An Introduction to Investment
A Simple Guide to Investment (an insert in Consider This) is published on behalf of Prudential Portfolio Managers by Touchline Custom Publishing, a division of Touchline Media, PO Box 16368, Vlaeberg 8018. Tel 021-408-3800 Fax 021-408-3811 Editor Deborah Herd Deputy editor Jane Surtees Senior designer Hilary Knight Publisher Andrew Sneddon Prudential consultants: Head of marketing Debra Roussouw Copy editor Shannon Edwards Contributors David Knee, Steve Powell Photographs Corbis Images, Getty Images, iStockphoto
ost of us work to live, rather than live to work. Most of us dream of the day when we don’t have to work and can enjoy life to the full.
To do this we need to consider investing for our future and making our money work for us, even when we are no longer working. When it comes to investing, the sheer volume of facts and information available can be incredibly time consuming to wade through and for many individuals the jargon used is just too confusing. Yet we need a good understanding of the ﬁnancial options available to us – and the risks and rewards associated with each – to be able to make good investment decisions. Prudential Portfolio Managers has built its reputation of prudent value investing upon a comprehensive understanding of markets and the many factors that inﬂuence the price of an asset. So whether you are an existing investor or looking to invest for the ﬁrst time, we thought the following simple questions and answers would help you by demystifying ﬁnancial markets.
Is my money currently working as hard for me, as I do to earn it? When you invest your money it will earn money for you… but, like everything else in life, there is risk involved. Because of this, many people choose the “safer” option, such as depositing their money with a bank or investing it in a Money Market Fund. It is the uncertainty about the risk of possible capital loss that may drive you to take the safest route but consider the following: • Shares have beaten cash almost two thirds of the time over all 10, 15 and 20-year periods since 1962; • South African equities have never delivered a negative return over any ﬁve-year period. The return earned on cash is directly related to the ofﬁcial level of interest rates set by The Reserve Bank. Therefore, when interest rates increase, cash returns increase, and when interest rates decline, the return on your cash declines. Interest rates in South Africa have been on a downward trend for the last decade, helped by generally lower levels of inﬂation. This has undermined returns from cash. Bonds, property and shares have, in contrast, beneﬁtted substantially from this. So, if all your cash is securely deposited in your bank, it is deﬁnitely not working as hard or growing as fast as it potentially could if invested elsewhere and with a longer term focus.
OK, so how do I get my money working harder but also smarter? Balance is an important part of life and the same is true with investments and the following need consideration. • Do you want low risk and low returns versus higher risk and higher returns… or a combination of both? • Do you want regular income versus capital growth… or a combination of both? Bear in mind that there may be tax implications of this choice depending on your circumstances and prevailing legislation at the time of investing. Your accountant may be able to clarify this matter with you. It is important to familiarise yourself with the types of investments available and the risk and rewards associated with each option. All things considered, ﬁnd the most ﬁnancially rewarding approach that balances your income needs with longer term capital growth. Low
Risk at a glance
Cash in a bank Historically, gives you better returns than cash, but are lower risk than equities Higher risk of default than investment-grade corporate bonds, but still safer than equities issued by the same company
Higher risk to capital than a mainstream equity fund, but gives you great potential for growth
Government bonds Funds investing in corporate bonds Funds investing in high yield corporate bonds Funds investing in larger, established companies (equities)
Funds investing in less well-established companies (equities) High
Your capital’s secure, but there’s little potential for it to grow
Slightly riskier than government bonds, but still safer than the stockmarket
Good growth potential, but you may not get back your original capital investment
What are bonds and what are equities? A bond is a loan made by you to a government or company when it needs to raise additional capital to ﬁnance new business opportunities. Bonds issued by governments are called government bonds, sovereign bonds or gilts, while bonds issued by companies are called corporate or credit bonds. Equities are shares in a company. When you buy equities, you are actually buying a share of the company itself. As a part owner, you share in the success or failure of that company and these fortunes are reﬂected in the share price on the stockmarket. So when the company does well and proﬁts rise, the value of your shares go up, and when it doesn’t, the value of your shares will fall. Bonds are generally affected by changes in interest rates rather than ﬂuctuations in the stockmarket. Their prices move less sharply than equities and they are thus often regarded as a safe-haven from stockmarket turbulence. Neither bonds nor equities are risk free so to reduce the risk of your portfolio you should consider balancing your investment portfolio with both bonds and equities in order to diversify these risks.
What is the difference between putting my money in a bank, a bond fund or investing in shares? Asset classes + Growth (capital & income) + Inﬂation protection + Fairly secure + Higher yield Return
+ Secure + Accessible + Regular yield
– Volatility (capital loss)
– Subject to interest rate cycle
– No inﬂation protection + Positive factors – Negative factors
If you are looking to grow your capital at a higher rate and are accepting of relatively higher risks, your portfolio would lean towards equities. If, however, you are not willing to take risks with your income, you may want to increase the percentage of bonds you hold. A rule of thumb to consider when calculating the percentage of bonds you should have in your portfolio is your age. If you are 58, for example, 58% of your portfolio should consist of bonds. Alternatively, if you are 63, then 63% of your portfolio should be in bonds, although individual circumstances vary and this is only a rough starting point. In the long run, equities should outperform bonds but bonds typically provide higher levels of income than both equities or cash in the bank. Bank deposit
Lower level of income
Higher level of income
Lower level of income which can ﬂuctuate
No growth in capital but the return of capital is mostly assured
Some opportunity for growth but capital is not secure
Higher possibility for growth but capital ﬂuctuates and is not secure
When is the best time for me to invest and for how long should I invest? Investing should be continuous and consistent because by investing often you smooth out the highs and lows of the market. When shares go down your regular contribution buys more than usual and when the share price subsequently rises, the value of your investment beneﬁts accordingly. Prudential explains: The ﬁnancial crisis of the past three years highlighted the fact that, over short periods of time, share markets can move up and down a great deal. In 2008, the price of the Johannesburg All Share Index, a basket of the shares of the largest 160 South African companies, fell 25%. In 2009, it proceeded to rise by some 28%. After allowing for the modest income from dividends, for someone who put a lump sum to work on December 31 2007, two years later the value of their investment would have got back to where it started. Hardly a stunning result. In contrast, if someone had put R1 000 in the market per month over that same period (a total of R24 000 over the two years), their investment would have been worth almost R28 000 on December 31 2009, demonstrating that, by investing regularly, much of the effect of market volatility is removed. Investing requires a long-term view and virtuous patience which in essence means an investment needs at least ﬁve years for its earning potential to be realised. We all want more money but that is just part of the reason for investing. The other part is how you want it delivered. This can be done in two ways: a ‘regular income’ (which gives you regular payments) or ‘growth’ (a big lump sum received at the end of your investment period). Smart individuals choose to invest with a long-term view but before you invest you must consider what you want from your money to determine the time you need to invest for.
I’ve decided I need to invest my money but how will my portfolio or fund be managed? The degree of risk is related to the type of fund you choose. How the fund is managed also impacts the risk involved. There are two ways your fund can be managed. Active management A highly experienced and specialised fund manager works on your fund constantly to maximise the proﬁts. They work closely with a research team and use their insight and knowledge to decide on the shares that are most likely to give a return on your investment. Passive management Index Funds. They are called ‘Tracker Funds’ and are not actively run by a fund manager. Their returns follow the performance of a particular index for example the FTSE/JSE All Share Index (which measures over 160 companies on our stock exchange). These are useful if you want to invest in a certain type of company or sector as some indices track particular sorts of companies. How do you know which investment approach is best for you? Selecting a top quality active fund manager should, in the long run, provide a better outcome than a passive strategy. However, this is not always easy. In addition, investors must then guard against the natural instinct of switching. Prudential’s track record in South Africa does show that, provided the manager has a disciplined and robust investment process, active management will usually out-perform passive management over time.
I can see how you can help my money grow but how do you help reduce the investment risk at the same time? Here are four simple ways that you can use to make investing less risky. Invest in an equity fund rather than single shares. In this way, your money is a pooled investment alongside other investors and managed by a fund manager. He ensures your money is spread across a number of different companies, sectors and even regions to avoid all your eggs being in one basket. Invest for the long term. Ideally, you should plan to invest for at least ďŹ ve or preferably 10 years. Markets tend to ďŹ‚uctuate over the short term but over the longer term the peaks and troughs tend to be smoothed out. Invest regularly. Investing at regular intervals can be a good idea as it is likely to mean the average price you pay for shares can be lower than if you make one lump sum investment. Over time, regular investments can help to smooth out the peaks and troughs in the market. Diversify your investments among different asset classes. Build a portfolio that includes higher risk investments like equities and lower risk ones like bonds or even cash. The particular balance of your portfolio, or asset allocation, will depend on your expected return, your attitude to risk, your age and your longer term ďŹ nancial goals. Asset allocation is one of the most important factors in investment success.
What is asset allocation? Asset allocation is the process of deciding how much money to invest in each asset class. To make the most of your asset allocation decisions, you ďŹ rst need an understanding of asset classes and the importance of strategic asset allocation. There are four broad classes of assets available to you when building an investment portfolio: shares or equities; bonds; money market and cash and equivalents; and property. It is important to have different asset classes in your investment portfolio to take advantage of the different strengths and characteristics of each class. The characteristics of each asset class vary in terms of their differing levels of income and the circumstance in which they may grow or fall in value. Some are easier to turn into cash (if you suddenly have unexpected expenses for example) and they all have different levels of risk.
Prudential explains: When you buy a share, you are participating in the ability of that company to grow in the future (or when the investment is in a fund, you want the proﬁts of that basket of shares in the fund to grow). There are many factors that inﬂuence how fast a company can grow, including the degree of competition in its market segment, the strength of the brand, the soundness of company management and so on. Companies differ in these regards. But one factor that affects all companies is how quickly the economy itself is growing. For example, if consumers are spending more this is likely to help companies increase their proﬁts as they sell more goods and services. Hence, over time, stronger economic growth should help share prices to rise. However, when economic growth is more robust, interest rates are likely to be rising. When interest rates rise, the prices of bonds fall, so, in general, economic expansion will be worse for bonds. Blending equities and bonds into a portfolio can therefore help to reduce overall volatility of your capital, as often when shares are doing well (the economy is growing strongly), bonds will be performing less strongly and, of course, the reverse applies when growth becomes more sluggish. Since economic growth ebbs and ﬂows over time, in what many see as a very unpredictable fashion, deciding on a broad allocation between these two assets that you stick to over time can help smooth your returns. Combining different asset classes in different proportions will help you achieve your investment objectives and take less risk to do so.
Asset allocation is basically the long-term diversiﬁcation of your portfolio between asset classes such as 60% to shares, 30% to ﬁxed interest and 10% to cash. Ideally, this allocation should match your longer term return and risk requirements. As we noted earlier, for most investors, decreasing riskier assets like property and shares in favour of bonds and some cash is a prudent course of action as you age. If you don’t wish to make asset-allocation decisions yourself, then you should ask your ﬁnancial adviser to assist you. At Prudential, we offer a range of solution funds where we do the asset allocation on your behalf.
What funds are there and how much do I need to invest? Fund
Risk ProďŹ le/ Asset Class
Min Lump Sum
Min Debit Order
Prudential Equity Fund
June 30 and December 31
Prudential Dividend Maximiser Fund
June 30 and December 31
Prudential Balanced Fund
Medium/Equity and Fixed Interest
June 30 and December 31
Prudential Global Value Fund of Funds
June 30 and December 31
Prudential High Yield Bond Fund
Medium to Low/ Fixed Interest
Prudential Global High Yield Bond Fund of Funds
Medium to Low/ Foreign Fixed Interest
June 30 and December 31
Prudential Global Income Plus Fund of Funds
Low/Fixed Interest and Equity
June 30 and December 31
Prudential InďŹ‚ation Plus Fund
Medium to Low/ Equity, Property, Fixed Interest and Cash
June 30 and December 31
Prudential Money Market Fund
Accrued daily paid monthly
Prudential Dividend Income Fund
Accrued daily paid monthly
Prudential Enhanced SA Property Tracker Fund
Medium to High/ Property
Prudential Enhanced Income Fund
Medium to Low/ Cash
Sector deﬁnitions According to The Association for Savings and Investments Code of Practice 20070607 Fund Classiﬁcation for South African Regulated CIS Portfolios*, Portfolios are deﬁned as:
These are collective investment portfolios that invest at least 80% of their assets in South African investment markets at all times. 6.1 Equity Portfolios Equity portfolios are collective investment portfolios that invest predominantly in shares listed on the Johannesburg Stock Exchange. These portfolios invest a minimum of 75% of the market value of the portfolios in equities at all times and generally seek maximum capital appreciation as their primary goal. All equity and derivative investments must conform 100% to the deﬁned investment requirement of each category. However, a) a minimum of 80% of the equity portfolio must, at all times, be invested in the JSE Securities Exchange South Africa sector/s as deﬁned by the category, and b) a maximum of 20% of the equity portfolio may be invested outside the deﬁned JSE Securities Exchange South Africa sector/s provided that these investments comply fully with the category deﬁnition. 6.1.1 Equity – General portfolios 6.1.2 Equity – Growth portfolios 6.1.3 Equity – Value portfolios 6.1.4 Equity – Large Cap portfolios 6.1.5 Equity – Smaller Companies portfolios 6.1.6 Equity – Resources and Basic Industries portfolios 6.1.7 Equity – Financial portfolios 6.1.8 Equity – Industrial portfolios 6.1.9 Equity – Varied Specialist portfolios 6.2 Asset Allocation Portfolios Asset Allocation portfolios are portfolios that invest in a wide spread of investments in the equity, bond, money and property markets. 6.2.1 Asset Allocation – Prudential Low Equity portfolios 6.2.2 Asset Allocation – Prudential Medium Equity portfolios 6.2.3 Asset Allocation – Prudential High Equity portfolios 6.2.4 Asset Allocation – Prudential Variable Equity portfolios 6.2.5 Asset Allocation – Flexible portfolios 6.2.6 Domestic – Asset Allocation – Targeted Absolute and Real portfolios 6.3 Fixed Interest Portfolios Fixed Interest portfolios are collective investments that invest in bond, money market investments and other income earning securities. 6.3.1 Fixed Interest – Bond portfolios 6.3.2 Fixed Interest – Income portfolios 6.3.3 Fixed Interest – Money Market portfolios 6.3.4 Fixed Interest – Varied Specialist portfolios 6.4 Real Estate Portfolios Real Estate – General portfolios
These are collective investments that invest in both South African and foreign markets. No minima are set for either domestic or foreign assets. 6.5 Equity Portfolios Equity portfolios are collective investments that invest predominantly in shares listed on stock exchanges. These portfolios invest a minimum of 75% of the market value of the portfolio in equities at all times and generally seek maximum capital appreciation as their primary goal. All equity investments must conform 100% to the deﬁned investment requirement of each category. 6.5.1 Equity – General portfolios 6.5.2 Equity – Varied Specialist portfolios 6.5.3 Equity – Technology Sector portfolios 6.6 Asset Allocation Portfolios Asset Allocation portfolios are portfolios that invest in a wide spread of investments in the equity, bond, money and property markets to maximise total returns (comprising capital and income growth) over the long term. 6.6.1 Asset Allocation – Flexible portfolios 6.7 Fixed Interest Portfolios Fixed Interest Portfolios are collective investments that invest in bond, money market investments and other income earning securities. 6.7.1 Fixed Interest – Varied Specialist portfolios
These are collective investment portfolios that invest at least 85% of their assets outside South Africa at all times. 6.8 Equity Portfolio Equity portfolios are collective investment portfolios that invest predominantly in shares listed on stock exchanges. These portfolios invest a minimum of 75% of the market value of the portfolio in equities at all times and generally seek maximum capital appreciation as their primary goal. All equity investments must conform 100% to the deﬁned investment requirement of each category. 6.8.1 Equity – General portfolios 6.8.2 Equity – Value portfolios 6.8.3 Equity – Varied Specialist portfolios 6.9 Asset Allocation Portfolios Asset Allocation portfolios are portfolios that invest in a wide spread of investments in the equity, bond, money and property markets to maximise total returns (comprising capital and income growth) over the long term. 6.9.1 Asset Allocation – Flexible portfolios 6.10 Fixed Interest Portfolios Fixed Interest portfolios are collective investments that invest in bond and money market investments and those which seek to maximise interest and rental income. 6.10.1 Fixed Interest – Bond portfolios 6.10.2 Fixed Interest – Varied Specialist portfolios * ASISA CODE OF PRACTICE, FUND CLASSIFICATION FOR SOUTH AFRICAN REGULATED COLLECTIVE INVESTMENTS PORTFOLIOS 18 March 2008
David Knee BSc in Economics (London School of Economics) MSc in Economics (Birkbeck College) ASIP (Associate of the Society of Investment Professionals)
David is Head of Fixed Income at Prudential. In January 2010, he also took on the role of Head of TAA. He joined the Prudential Group as part of the Fixed Income Team based in London in 1997 and transferred to the South African ofﬁce at the end of 2008. Prior to working at Prudential, he managed ﬁxed income portfolios for another London-based asset manager. Prior to working in asset management, in the early 1990s, he was employed as a Fixed Income Economist for an Investment Bank. Alongside his role as Head of Fixed Income and TAA, David is also a member of Prudential’s Asset Allocation Committee.
The views and opinions expressed by the independent authors and those providing comments are theirs alone, and do not necessarily reﬂect the views, opinions, or strategies of Prudential Portfolio Managers or any employee thereof. Prudential Portfolio Managers is an authorised Discretionary Financial Services Provider in terms of the FAIS Act, 2002. Collective Investment Schemes in Securities (CIS) are generally medium- to long-term investments. The value of participatory interests may go down as well as up and past performance is not necessarily a guide to the future. CIS are traded at ruling prices and can engage in borrowing and scrip lending. A schedule of fees and charges and maximum commissions is available on request from the company/scheme. Commission and incentives may be paid and, if so, would be included in the overall costs. Forward pricing is used. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. In calculating performance ﬁgures, initial charges are not taken into account (ie NAV-NAV). Annual service charges are deducted in all calculations. Dividends are reinvested on the reinvestment date at the reinvestment price. For more information, visit www.prudential.co.za or call 021-670-5100.