How do I select a proper investment vehicle or product matched to an acceptable level of risk for an appropriate return on investment, tied to achieving a specific investment goal? These are the key questions that all investors grapple with, or at least should be before investing their money.
The fact that many people don’t was recently exposed when Absa announced it was shutting down its large and popular Absa Money Market Fund (AMMF) on July 6.
Outlining its reason for the closure in a letter to its clients, Absa said a survey done by it revealed that most clients erroneously believed the AMMF to be a bank account with both capital and associated returns being guaranteed by the bank.
The AMMF is, in fact, a collective investment schemes product (also known as a unit trust) and therefore capital and returns are not guaranteed, which increases the risk – a rather serious misunderstanding.
Absa may perhaps have had a few other reasons too – as has been widely speculated in the market.
These could possibly include the current low interest rates with fees being proportionately higher than when interest rates are high; concern over credit risk; or perhaps Absa felt it was giving away business via various debt instruments used by the fund – including other banks – that could instead have been channelled to its own banking products.
But its stated reason is nonetheless a very valid one that raises serious concerns.
Misconceptions regarding funds
Unwittingly, these AMMF clients were exposed to risks that they were seemingly totally unaware of.
The AMMF itself stated in its fact sheet that the fund – like all money market funds – was an ideal vehicle for short-term investments, to achieve a competitive interest rate with provision for immediate liquidity as an “attractive alternative to savings and deposit accounts”. It was characterised as being “suitable for investors who seek capital preservation with minimal volatility” and advised a three-month term as most suitable and having the lowest risk.
But in fact, we often find that investors will use a money market fund incorrectly for long-term savings or even to draw a monthly income, along with other faulty assumptions about its best use.
While the overall risk here is that of being oblivious of the risks involved in being incorrectly invested for incompatible reasons, specific risks include inflation risk, concentration risk, credit risk or the risk of default, and the risk of running out of money.
The credit risk, or the risk that Absa specifically would default on its obligation to investors, is arguably very low, but it remains a risk, nonetheless.
And the other specific risks mentioned are often totally neglected or disregarded but should always be considered.
Now thousands of AMMF clients will be seeking alternative investments for their money, collectively totalling more than R75 billion.
Questions they will, or should, be asking include what alternative investment options are available? Do they understand why they are invested in the money market or what it can or cannot do for them? What risks do they need to be aware of? And how should they go about moving their money out of the AMMF in the 90-day period allowed by Absa into an alternative investment product or vehicle?
Some of these questions will be best answered by seeking the advice of a credible financial advisor who is qualified, holds professional indemnity insurance, is registered with the Financial Sector Conduct Authority and who is totally transparent about the fees you will be charged.
However, it’s worth taking a deeper look at each of the other risks mentioned.
This risk materialises when inflation outstrips the investment and starts eroding the real value of your investment. To explain: if you invested R1 million into a fund that over time underperformed inflation, at some point in the future the capital will buy you less than what the initial R1 million could, even if, perhaps confusingly, the investment could in nominal terms now be more than the original R1 million invested.
This risk results from investing too much into one asset class and not being sufficiently diversified. For instance, if all your capital is invested into a money market fund with fixed interest and this asset class underperforms over time or even fails, you will suffer a significant loss. Your risk is reduced, or spread, by diversifying into different asset classes that will react differently to political, economic and other events.
Risk of running out of money
Clients often draw a regular income from their money market fund investments, in itself not a bad thing providing you have enough capital invested into other growth assets that will enable your portfolio to grow. But if you are dependent on the capital in the money market fund for both growth and income, then the life of your capital can be drastically reduced.
As Absa warns in its AMMF fact sheet, there is a risk that the issuers of fixed income investments used by the fund (such as bonds) may not be able to meet interest payments nor repay the money they have borrowed.
When considering alternatives
For those clients who have used their money market funds like bank accounts, the alternative may be to indeed switch to an ordinary bank account. However, this may involve costs at low interest. Similar returns are possible with a fixed term investment, but then you’d lose the liquidity of a money market fund.
If you decide to remain in a money market fund for quick access to savings, stability and reasonable returns, be aware of the short-term purpose and the risks involved.
Now may be an excellent time to review your entire portfolio, ensure you are well diversified with sufficient offshore exposure, while evaluating all the other relevant factors. It’s always best to engage with a qualified financial planner or wealth manager to assist you with these important decisions.
Marc du Plooy is MD of Wealth Associates South Africa.
Luister: Kokkie Kooyman, direkteur en fondsbestuurder by Denker Capital, praat oor Absa wat sy geldmarkfonds sluit