A Fin24.com user asks:
What opportunities are there for "high savers" to maximise wealth during these hard economic times?
Craig Gradidge of Gradidge-Mahura Investments responds:
For high savers and people with cash available to start a savings plan, the environment offers a lot of opportunities for investors to create wealth over time.
Asset prices have taken a beating over the past six months as a result of numerous factors which can largely be traced to the subprime crisis in the US. The JSE is down close on 45% from its peak, the currency has weakened 50% since the beginning of the year, and the S&P Index is on course to deliver its worst returns since 1931 when it lost in excess of 40% in that calendar year.
It is not easy to commit capital to investments when there is doom and gloom all around us, but history has shown time and again that these usually are the best times to invest and patient investors are rewarded with above-average returns after such periods. We do not know when the markets will turn, or what will cause them to turn, but we do know that they will.
When it comes to maximising wealth one needs to:
- Limit the search to growth assets (assets where the bulk of the return is in the form of capital growth);
- Reduce tax liability;
- Take a long-term view (at the very least three years, but a five year horizon is preferable); and
- Continue to apply the principle of diversification.
The opportunity that gets us excited the most at the moment is that the fall in share prices has resulted in dividend yields increasing to levels last seen before the start of the most recent bull market. It is expected that some companies will report lower earnings and potentially cut their dividends, especially those that have increased capital requirements (such as the banks), but there are companies that should at least maintain their dividends at current levels (such as those companies that had high dividend covers to start with).
The environment has created an opportunity for astute investors to lock in fairly high dividend yields. Because dividends generally indicate a profitable and cash-generative operation, companies paying high dividend yields and with long track records of paying dividends tend to recover quicker once the market turns.
Further evidence of this comes from the fact that the top-performing general equity fund in the country in 2004 was a fund whose mandate was to invest in high-yielding shares. The other attraction of the dividend strategy is that over time, dividends tend to grow resulting in an increasing cash flow to the investor.
An amount of R100 000 invested into the fund referred to earlier in November 1998 has yielded R116 000 in dividends and has a capital value of over R400 000 currently. Had the investor simply reinvested the dividend for the first 5 years and then started receiving dividends, that strategy would have yielded R99 000 in dividends with a current capital value in excess of R500 000.
Currently there are three product providers with funds that invest primarily in dividend yielding shares: Old Mutual, Prudential and Satrix.
Preference shares?
With the interest rate cycle starting to look a bit toppish, a patient investor could do well by getting some exposure to select preference shares. Preference shares have fallen off quite a lot in the past year in the face of increasing interest rates, rapid deterioration of trading environment for banks (the main issuers of preference shares), and changes to tax treatment which have caused investors to adopt a wait and see approach to this asset class.
Preference shares receive a dividend (linked to the prime rate) ahead of ordinary shareholders, and their main attraction is the high tax-free yield. An investment into this asset class could generate solid returns for investors over the next few years as the interest rate cycle turns, and as tax treatment becomes clearer and confidence returns.
There are two options for the retail investor with Sanlam and Coronation offering funds in this space, although these are not homogenous funds so be sure to consult a financial adviser when deciding on which is the more appropriate for your particular risk tolerances and requirements.
Another asset class that has suffered huge losses has been property, particularly listed property, on the back of increasing interest rates, weaker currency and deteriorating economic conditions. The attraction of listed property is that it has the potential of large capital increases and over time offers a growing yield.
The result of the fall in capital values over the past year is that one is able to lock in higher yields than were available just a year ago. The added attraction for investing in listed property in South Africa is that there are a number of large institutional investors that have publicly stated an intention to increase their exposure to this asset class.
This provides a solid underpin to the asset class, as these investors provide a ready supply of buyers in the market. One of the largest unit trust funds in the sector has delivered on a R100 000 investment made 5 years ago, R55 000 income and a current capital value of R110 000. If an investor reinvested income for the first 2 years, then total return now comprises R40 000 income and R140 000 capital value.
Private equity
Finally, the one investment opportunity that has been largely ignored by retail investors has been private equity.
This has largely been available to upper-end investors with large lump sums available to invest, although there are a number of options open to smaller retail investors such as those offered by Old Mutual and Momentum (although these funds are not always open for new investments).
Figures provided by one of these companies show that PE has managed to deliver alpha (outperformance) of 13.9% p.a. in the UK over the past 10 years to end December 2007, while delivering 15.4% to end-March 2008 in the United States.
The attraction of private equity is not only the amount of alpha that it has been able to deliver over equity returns. The main attraction from a financial planning and growth strategy perspective is that one is able to reduce the risk inherent in a growth strategy because of the low correlation between listed equity and private equity.
A paper presented at the Convention of the Actuarial Society of South Africa in October 2006 showed a number of PE funds having a correlation with equity at between 0.17 and 0.02. To understand why this is important, consider a portfolio consisting of an equal exposure to an equity fund and a private equity fund. Assume that both funds have a standard deviation of 25% (a measure of risk - a higher standard deviation implies more risk).
A simple mathematical average will suggest that the portfolio will also have a standard deviation of 25%. However, that is not the case. If we assume that the two investments had a correlation of 0.2, the portfolio risk comes out at 19% - almost a quarter less than expected.
In the end wealth creation is a process that takes time, discipline and a dose of common sense. If investors are seeing this as an opportunity to try time the market then the opinions shared here are unlikely to prove useful. The principles of investing remain the same in bear markets and in bull markets.
- Craig Gradidge is a director of Gradidge-Mahura Investments (Pty) Ltd, an authorised financial services provider. Contact him at craig@gminvestments.co.za