A minefield of technical jargon in the field of investing leaves many people feeling inadequate, uneducated and incapable of understanding this field of financial planning. Many advisors use investment terms colloquially in their everyday lives, forgetting that their clients don’t necessarily have insight into what these terms mean.
When it comes to investing, there are four main asset classes available to you: cash, bonds, property and equities. While cash is the safest asset class, it also generally provides the lowest returns over time. Bonds, on the other hand, involve government, local authorities or corporates borrowing money from investors and issuing them with a debt instrument called a ‘bond’, with the investor being entitled to annual cash fixed interest payments. Property is a very broad asset class as it covers all aspects of real estate including corporate, industrial, residential, farm and rural property. Equities, which are effectively shares in a company, are considered the highest-risk, highest-return asset class. While bonds and cash are considered safer investments, equities and property provide greater protection against the effects of inflation in the long term.
As mentioned above, equities are essentially shares in the ownership of a listed company. When a listed company offers equities, it is effectively offering investors the opportunity for partial ownership in that company. Equities are high risk because their price can be dramatically affected by short-term market volatility, although in the longer-term equities have proven their mettle and are able to generate favourable returns given an adequate time horizon. The amount of equity exposure you have in your investment portfolio effectively determines the risk profile of your portfolio. So, if you are young and investing for your retirement, you are able to incorporate more equity exposure into your portfolio. If your investment horizon is shorter, you may want to de-risk your portfolio by incorporating less risky asset classes into your strategy.
Simply put, offshore investing means investing your money in a jurisdiction other than your own country of residence. In South Africa, every person aged 18 and over who is in good standing with Sars may take R11 million offshore annually. Of this, the Single Discretionary Allowance of R1 million, which is not subject to Sars approval, may be used for legal expenses such as travelling, gifts, education or investing. The balance of R10 million referred to as the Foreign Investment Allowance requires Sars approval if investing directly offshore. Direct offshore investing involves opening up an offshore bank account in the foreign country and physically sending your rands overseas. Alternatively, you have the option of investing indirectly, this would not require Sars approval. This involves investing in rand-denominated funds which gives your money foreign investment and currency exposure while your money does not actually leave South Africa.
Index or passive investing
Index funds offer a low-cost way for investors to track popular stock or bond market indices. Thousands of indices track the movements of various sectors, markets and strategies on an ongoing basis, for instance, the JSE Top 40 which is made up of the largest 40 stocks on the Johannesburg Stock Exchange. While you cannot invest in an index (which is just a mathematical concept), you are able to invest in an index fund which effectively aims to mimic the composition of the selected benchmark such as the Vanguard 500 Index Fund, for instance. Index funds are passively managed and provide investors with the opportunity to track popular stock or bond market indices. Indexing is mostly automated and therefore does not involve as much ongoing research and analyses by fund managers and analysts, resulting in lower costs and more fee transparency.
As opposed to tracking indices, active investing involves a more hands-on approach to investing. The portfolio or fund manager actively manages the fund in accordance with their investment process, philosophy or style, with the aim being to beat the stock market’s average returns. Active investing usually involves a portfolio manager who is supported by a team of investment analysts who make changes to the investment strategy as markets fluctuate. Active investing requires skill and confidence on the part of the portfolio manager and, because it requires more intense management of the portfolio, the fees are generally higher than passive investing.
Actively managed investment portfolios require the expertise of fund managers who are effectively responsible for implementing the fund’s investment strategy. A fund can be headed up by one fund manager or by a team of fund managers who generally earn their fees as a percentage of the fund’s assets under management. The fund manager actively manages the assets within the fund by making purchasing and selling decisions and portfolio construction decisions which they believe will best achieve the stated target of the fund.
With there being over 1 000 unit trust funds for South African investors to choose from, multi-managers play an important role in researching and analysing all the funds offered by various assets managers and building portfolios from these to achieve a specific objective. A multi-manager, therefore, builds an investment portfolio by strategically allocating capital to carefully selected funds in line with the client’s mandate. Whereas a fund manager actively invests funds, a multi-manager selects from the actively managed funds and passive funds both locally and abroad to design a bespoke portfolio for the client. A multi-manager approach means that the client benefits from the investment expertise of more than just a single fund manager. In addition, economies of scale make investing through a multi-manager fairly cost-effective.
Collective investments, or unit trusts, are transparent, well-regulated and easy-to-understand investment vehicles, and are well-suited to a wide range of investment objectives. Unit trusts provide you with an economical way to invest any quantity of money whilst still obtaining the same level of professional management and diversification of investment. Distinct advantages of unit trusts are that they include professional portfolio management, the ability to diversify a portfolio cost-effectively, relatively low transaction costs and the ability to buy and sell at will. As the owner of unit trusts, you would essentially be a unit holder in a fund that in turn invests its money in a range of assets, including shares, property, bonds and/or money market instruments, depending on the mandate of the fund.
When investing for your retirement, investors will often hear the term ‘approved fund’. Approved funds are retirement funds which fall under the ambit of the Pension Funds Act and are registered with the Financial Services Conduct Authority (FSCA) and include pension, provident, preservation and retirement annuity funds. Approved retirement funds are subject to Regulation 28 of the Pension Funds Act which limits the extent to which retirement funds may invest in particular assets or in particular asset classes, with the main purpose being to protect the members’ retirement provision from the effects of poorly diversified investment portfolios.
Often referred to as compulsory funds, a life or living annuity is an investment that can only be accessed/purchased when you retire from an approved retirement fund. When an investor retires from his pension, provident, preservation or retirement annuity fund, he has the option to purchase either a life annuity or a living annuity, with the aim of the investment being to provide a compulsory income for the retiree. A life annuity is effectively an insurance policy with the retiree being the policyholder and where the insurer guarantees the payment of a pre-determined annuity income. On the other hand, a living annuity is an investment in the name of the retiree where the retiree can draw down from his investments anywhere between 2.5% and 17.5% of the value of the fund per year.
A balanced fund is a hybrid fund that generally includes a static mix of assets including equities, property, bonds and sometimes money markets, with the typical mix being no more than 75%. A balanced fund, which provides investors with exposure to the markets while still providing protection from an economic downturn, is considered a low-to-medium risk investment depending on the percentage allocation to equities and property and is often suitable for retirees or passive investors.