Please advise on my current investment portfolio. Local equity holdings 35.20%, offshore equity holdings 17.63%, local bonds 21.18%, local cash and fixed income 13.32%, local property 3.77%, offshore bonds 3.28%, offshore cash 2.58%, offshore property 0.44%, other 2.60%. I’d like to know whether the percentage allocations to each fund is good or how I could allocate them better.
When structuring your allocations to the various asset classes (equity, property, bonds and cash) and the selection of local versus offshore, it is first important to understand what your investment objectives are. It is also important for us to understand your investment time horizon as well as the investment return you are aiming to achieve over that period to advise you on an appropriate weighting in respect of these various asset classes.
Asset allocation is the major contributor to investor performance, as William Sharpe, a winner of the Nobel Prize for Economics, found in his research. In his studies, Sharpe found that an average of 90% of the monthly variation in returns can be explained by asset allocation, while only 10% was explained by specific share selection.
The primary objective of investing is to achieve above-inflation returns to ensure that you receive real growth on your investments. Inflation has the effect of decreasing one’s purchasing power over time. For instance, you could buy more with R1 000 in 2010 than in 2020. As such, asset classes can be separated into growth and inflation-matching (or defensive) sections.
Growth assets include equity and property markets, while defensive assets include bonds, cash and fixed income.
The objective of growth assets is to achieve long-term outperformance of inflation to keep one’s investments increasing in value in real terms. Historically, an investor can expect a return of inflation plus 6% from equities and inflation plus 4.5% from property. When investing on the defensive side, your purpose would primarily be to ‘park’ capital in the short- to medium-term, and to retain the purchasing power of those funds against inflation. Your expectations in respect of investment returns from bonds should be around inflation plus 2%, and inflation plus 0.5% for cash and fixed income.
In terms of understanding your current asset allocations, it is evident that you hold a blend of growth and defensive asset classes, with a weighting of approximately 60% growth and 40% defensive assets. The graph below reflects how you are currently invested:
Determining how to better allocate your assets is relative to your objectives and investment timeline. If you are investing for the long term, as for retirement or financial independence, then a larger allocation of growth assets would be more appropriate. Short-term market volatility should be overlooked, and your focus should rather be on long-term inflation-beating returns.
If your needs are more immediate, such as a deposit on a vehicle or property, then it would be advisable to have a greater share in the defensive assets classes to protect your funds from short-term market volatility.
For example, the JSE recently experienced a large and sudden drop. Between February 21 and 28, due to fear and uncertainly around the coronavirus outbreak, the markets fell by 10.98%. If you had been in the process of buying a house at the beginning of March 2020, your deposit would be worth significantly less as a result of his sharp decline. On the other hand, if you are a long-term investor, this same decline in the markets could create an opportunity to buy good quality but undervalued assets for long-term investment purposes.
While historically we expect growth assets to outperform defensive assets, there have been shorter periods where the opposite has been true.
Over the last five years, the best performing asset class in South Africa has been the bond market, while equities have barely kept pace with inflation. The challenge is that hindsight is a perfect science and we cannot reasonably expect to predict with any certainty what the next five years hold for us. It is therefore important to focus on the fundamentals of asset allocation over the appropriate time frames.
With this in mind, our advice is to first identify and understand your investment objectives with respect to timeline and returns. Once you have clarity on these matters, you will be able to undertake strategic asset allocation to align your portfolio with your goals.