When your income starts to dwindle…
These are trying times for conservative investors
By Cassie Carstens
27 June 2020
Among the three largest money market funds (Absa, Ninety One and Allan Gray) and the three largest income funds (Coronation Strategic Income, Prescient Income Provider and Nedgroup Investments Flexible Income) no less than R250 billion is invested.
These funds are utilised for various needs – from parking funds short-term (mainly in the money market) to using it as building blocks of asset allocation for more conservative portfolios.
But people who are currently invested in this space, will find themselves between a rock and a hard place, now and in the foreseeable future.
Global fiscal and monetary stimulus packages that resulted from the Coronavirus pandemic – amongst others, the drastic reduction of the South African repo rate from 6.5% at the beginning of the year to 3.75% currently – has caused the yield on short-term (“safe”) interest-bearing instruments to fall to a level where investors will battle to beat inflation after tax.
Investors who use these funds to generate an income, will not be able to keep up in real terms. They have to realise that the playing field has changed and circumstances have delivered a blow in the gut of their financial plans, similar to what investors in more aggressive investments experience when markets decline from time to time.
However, the difference is that markets often recover relatively quickly, and these investors usually have the option to withdraw income elsewhere while they allow their investments to recover.
With fixed-interest investments, you cannot move your money to more aggressive investments to give the conservative part of your portfolio a break.
To add injury to insult, investors in fixed-interest investments suffered capital losses in March. For example, the Coronation Strategic Income Fund was 6.87% lower on the 22nd of March than on its peak just a few days before.
See the table with the current returns of the biggest money market funds. These rates will probably drop even lower over the next few months.
Yields that drop this much, lead almost without exception to behavior that we call “reaching for yield”. It is the search for better returns without taking more risk (from your perspective) that leads investors to questionable investment schemes.
What is the alternative?
You have to first decide why you want low-risk exposure. It makes sense for an emergency fund, but if you keep it as part of a long-term plan, you may need to reconsider it.
What is risk?
Corrections are painful, but typically happen rapidly. Bull markets last much longer and usually starts just after a correction. Large declines in market values often cause a perception of unacceptable risk while a sharp drop in income from conservative investments is strangely not seen in the same light.
The one wipes out a portion of your capital abruptly and the other over a longer term, but make no mistake, both have implications for the protection of your wealth.
The accompanying graph shows that equities are more likely to outperform money market if allowed the time to grow. Your investment horizon should therefore be part of your decision-making process.
I am not implying that people who are currently 100% invested in money market or other interest-bearing instruments need to change strategy and invest 100% in more volatile asset classes such as equities and property. The point that I am trying to make is that a certain percentage exposure to growth assets is not only meaningful but can be essential.
A combination of income funds and low-equity funds is a sensible alternative.
The purpose of an income fund is to generate a return better than money market without significantly increasing your risk. This is achieved by using bonds (government, corporate and inflation-linked), fixed-rate or variable rate cash instruments, preference shares, listed property, currency hedging and so on.
Investors are however advised not to change course on a whim without discussing with a professional with the necessary experience and know-how, who takes into account your specific situation and requirements.
Unfortunately, this creates a further challenge. In the low-income returns space, advisory fees (as a percentage of the total return) are now almost 50% more compared to your total yield (if the yield decreases from 9% per annum to 6% per annum and if the advisory fees are 0.5% per annum).
It is therefore important that the value you derive from the relationship is more than the cup of coffee that you enjoy together once a year.
In conclusion: The caveat of following an investment strategy where you are anchored to one outcome (e.g. you invest everything in money market, abroad or in property), is that a single change in circumstances (e.g. a decline in interest rates) can instantly derail your planning.
You can make use of income funds as a building block, but not with 100% of your capital.
South Africans remain in unique circumstances.
We have to repeatedly overcome things such as load shedding, junk status, day zero water situations and now the coronavirus pandemic – and somehow, we manage to do so.
The same resilience combined with a better understanding of what you need to invest in, will get you to your long-term investment goals.
Cassie Carstens is a certified financial planner of ProVérte Wealth and Risk Management. Contact him at email@example.com.
Although all possible care was taken in the drafting of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone planning on taking any financial action based on this document, is strongly advised to first consult with their personal financial advisor. ProVérte Wealth & Risk Management is an authorised financial service provider with FSP no. 5966.