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Investment Strategy
Sunday, January 1, 2012
Not so daunting

A guarantee is generally supposed to put us at our ease when deciding on parting with our cash. This goes as much for physical goods as it does for financial services and investments. But if we look close enough we may find that not all guarantees will pass scrutiny.

Take the case of the so-called ‘guaranteed investment products’. These might promise to guarantee a predetermined, after-tax return over a specified investment period of usually five years, for example. Offered in a policy structure, they lock you into the policy for the agreed period of time in exchange for delivering the growth as promised at the outset of the investment.

However, consider that the average return offered by local guaranteed products for the next five years is 5.8%. With the inflation rate currently sitting at 5.3%, this effectively means that guaranteed products will, on average, deliver a real return of only 0.5%. This, of course, assumes inflation remains flat – leaving you only marginally better off in real terms than you were when you purchased your policies. Should we see inflation rise to above 6%, investors currently committed to the same five-year guaranteed product policies will have made a loss in real terms when these policies reach maturity. And because they are locked in they will be stuck with the deal.
Observes Nico Coetzee, Executive: Business Development at PPS Investments, “At the same time, you would have missed out on other opportunities to generate real returns.” With inflation, say, at 6% your guaranteed product would prevent exposure to higher growth potential and means you would be unable to take advantage of any favourable market conditions.
Note that guaranteed products are linked to a predetermined investment term, which means that you are locked into the policy which, Mr Coetzee adds, also carries additional costs compared to a normal market related investment.
Inflation-linked products should be considered a better alternative to guaranteed products. “These aim to provide growth that either equals or outpaces inflation, are invested in the equity market to varying degrees, and are actively managed to achieve their stated benchmarks,” he says.
Although more conservative investors may instinctively shy away from equities due to the perceived volatility of the asset class, a clearer picture emerges when looking back at historic market returns. “Let’s consider the annualised performance of the ALSI, the Johannesburg Stock Exchange’s All Share Index, since 1974 over rolling five-year periods – the standard term of a guaranteed product.”

As we can see from the chart the ALSI – the broadest measure of South African stock performance – has not once generated a negative rolling five-year return in over 37 years. In fact, the lowest rolling five-year return recorded over this period was 3.5%. “So had you invested solely in the South African stock market for any consecutive five years since 1974, you would never have made an outright loss,” he points out. “You would also have been able to generate a return of anywhere up to 46.4% (and an average return of almost 20%), giving you huge upside potential on the average guaranteed product return. From this point of view, the equity market is not nearly as daunting as investors may think.”
This performance is, of course, not guaranteed, but does put long term investing into perspective. It should also be remembered that the returns highlighted above would have been earned on pure equity investments. However, inflation-linked products can be invested in a number of different asset classes. A more conservative investor would therefore be able to invest in an inflation-linked product with a balanced mandate. This gives the added safety of greater diversification and lower volatility while the product still seeks to generate real returns. Through active management, inflation-linked products further hold the potential to outperform their inflation-linked benchmarks, which means that prospective returns are never capped.
“This is evident when considering the annualised rolling five-year returns of four quality inflation-linked funds with balanced mandates, all of which are available on the PPS Investments platform. For our purposes, we’ve compared the performance of these products to a benchmark return of CPI+ 4%.”
“When taking into account that inflation-linked funds are not subject to fixed investment terms, quality inflation-linked funds therefore hold the potential to offer a significantly better proposition than guaranteed products,” enthuses Coetzee.
A well-constructed portfolio of inflation-linked funds offers a great alternative to these products and should be discussed with your financial intermediary when evaluating the investment choices available to you.

Moonstone Information Refinery (Pty) Ltd, Investment Rates 19 September 2011

Copyright © Insurance Times and Investments® Vol:25.1 1st January, 2012
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