Investigating investments: what defines a good investment?
01 November 2017
Balancing expectations with reality is an invaluable skill, yet one that remains elusive to most of us. Unreasonably high expectations often lead to disappointment yet we never fail to dream big.
Therefore, it’s not surprising that many of us enter the world of investments with pipe dreams of striking it rich in just a few years, when the successful investor is, more often than not, whoever has the most patience.
To try and make sense of it all, we sat down with Absa Wealth and Investment Management’s Head of Fund Managers, Sylvester Kgatla.
The definition of a ‘good return’ doesn’t exist
Take this with a pinch of salt. Sure, you get good and bad investments, and with these come good or bad returns, but the point here is that a ‘good return’ on an investment is entirely relative.
“South Africa is emerging from an era of abnormally high returns,” says Sylvester, “Up until 2007 we were seeing returns greater than 20% annually in the property market, with 10-15% on bonds and equities.”
“In ’98, the interest rate reached 18% or so and you would see returns of 15-16% on risk-free Money Market funds. This leads to a generation of investors with unrealistically-high expectations of massive returns, and many of the older investors still have this mindset. These days a measure of success in investing is often just ensuring wealth protection, not losing your money, and many of these old-school investors aren’t satisfied with that.”
So, then how can we describe a good return on an investment?
Sylvester believes a good return is unique for each investor: “It’s entirely dependent on your mandate and what you’re hoping to gain from your investment. Perhaps you’re after capital preservation, in which case you might hope to see returns in line with inflation. Or you’re looking for more growth, what we might call a ‘sleep at night’ investment, a conservatively moderate approach, from which you would hope to see a return of inflation plus 2 or 3%.”
“In essence, a good return for an individual is relative to their expectations and their appetite for risk. What’s seen as ‘good’ for one investor, may not be for another.”
Do you like living dangerously?
Risk plays a major part in defining your own ‘good’ investment. Your appetite for risk is highly dependent factors such as your goals, your age, your level of disposable income. Often younger investors in a good job, far from retirement, have a greater risk appetite, as they aim to grow their capital and push for higher returns to stand them in good stead later on in life. Conversely, as one approaches retirement age, risk aversion may increase, as one aims to preserve and maintain wealth rather than growing it. Of course, this doesn’t always hold true, and many retirees may have more disposable wealth that they are willing to lose in order to see larger yields in their twilight years.
Therefore, before investing (particularly for the first time), it’s standard practice to undergo a risk assessment profile. This will determine your appetite for risk, aligned to your investment goals, and to decide how conservative or aggressive your investment strategy should be.
Unfortunately, although many of us may believe we are ready to take the risk for a larger reward, when things go wrong, we tend to panic.
“People are very susceptible to panic, and this can ruin their investment success,” Sylvester admits. “As soon as bad news reaches them, they panic and pull their investments with the intention of reinvesting when the market stabilises again. The problem is that the man on the street generally gets the news late, so they hear of a dip in the market and sell low, but by the time they hear the market has turned again and buy back in, they’re already too late and end up buying high. Overall, they end up making a loss, when, had they been patient and avoided acting out of panic, they probably would have weathered the change and seen their investment remain constant.”
In a game fraught with inherent risk, if you claim to have an appetite for such, you had best be able to button down and ride out the bad times if you wish to see the good.
Sylvester cites the case of a client who invested R10 000 into a newly launched Absa equity portfolio in 2004 and then left it there, unmoved, unchecked, safe and sound for the long haul. Today that investment is worth over R100 000. Simply choosing a good portfolio and having patience saw a return of over 900%, which most would objectively define as a ‘good return.’
This is a contentious subject for many investors. Over time, high fees can eat into your returns, a frustrating prospect, particularly when some funds incur near-negligible fees and outperform others with higher fees.
Essentially, there are two players in the fund manager game: those with an Active approach and those with a Passive approach. The Active fund manager believes that markets are intrinsically more complex than numbers and patterns, and believe that they are adding significant value to warrant higher fees. The Passive manager will tell you this is unnecessary, that a calculated investment and computer-driven algorithms will do the work and ultimately yield the same return as an active approach, thus these high fees are not a true reflection of value.
Ultimately, it comes down to what works for you.
“In terms of fee structure, you have either a flat or performance-based fee,” says Sylvester. “The flat fee, for instance, being 1% of the investment value on a daily basis, so if you invest R10 it would be 1% of that divided by 365. If the fund increases in value, the 1% is worth more for the manager and vice-versa if it decreases, so it’s in their interest to see that fund perform. This flat fee is easy to understand and generally considered fair for both parties.”
“The performance-based fee kicks in when a benchmark or target, usually the JSE All Share Index, is hit or exceeded and the manager charges 1% plus 10% of the over-performance on the benchmark. Conversely, if the fund drops below the benchmark there are no performance fees and the manager simply charges 50 basis points, for instance. The performance fee is based on a set rolling period and doesn’t always reflect the most current performance or come into effect from when you first invest, so it’s inherently more complicated and many investors may feel it’s a little unfair.”
Fund managers usually have a diverse portfolio of products with different fee structures for you to choose from, based on what works for you and your investment goals. The names of the funds are also regulated for consistency across the spectrum, so you will know you’re getting the same product should you wish to shop around at different fund managers and find the fee structure and manager most closely aligned to your goals.
Absa also offers a range of Tax-Free Funds with no performance fees, such as the Tax-Free ETF and Tax-Free Unit Trust, which are relatively cheaper and generally have better returns, and, of course, you won’t be taxed on said returns. A great starting point for a first-time investor to cut their teeth on a relatively low-risk investment.
When it comes to choosing an investment type to suit your investment term and level of risk, Sylvester offered up some invaluable insight:
“For a term of up to 5 years, you might do well to look at a balanced or managed fund. A multi-asset fund in bonds, equities or cash, with a flexible mandate that allows your fund manager to move between these asset classes depending on market conditions.”
“Five years plus might see you move into equity funds. If you’ve got a decent appetite for risk you could look at a single asset class, such as property. This can be highly volatile, as you can only move from one stock to another should the market turn, instead of being able to move between asset classes. There’s inherent danger, as the whole market can be affected when something goes south, but the potential returns are significantly higher.”
And when it comes to choosing said manager, Sylvester believes it comes down to a combination of factors.
“You have to balance your appetite for risk, your investment goals and your expectations, then find a fund manager that aligns with your unique investment profile. Look at their long-term performance and brand. Do they represent themselves or a larger entity? Do they have a consistent and sound track-record? Carefully consider the fees they charge and the value you get back. If one manager is charging 150 basis points and another 85, you’re already ahead on your investment if you choose the latter, provided they perform at a relatively similar level. Some may choose higher fees based on brand and track record, and that’s fine too, but always consider how higher fees erode your returns over time.”
Finally, on the subject of investment awards, Sylvester suggests caution: “The ones to watch are Raging Bull and Morning Star, but if someone wins an award one year, then falls off the map for the next 5, you might want to take heed. Awards hold value in repeat performance and in conjunction with a consistent track record, they don’t mean much in isolation”
At the end of the day, when it comes to investing, your best bet is to look, think and act long-term.
Disclaimer: The advice contained on this blog is for general purposes only and does not take into account individual circumstances, objectives or financial needs. Accordingly, readers are advised to seek appropriate advice from licensed professionals prior to making any investment, or taking up a financial product or service.