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How not to be safe and sorry

Johannesburg – As rates go down by another 50 basis points, the case for fixed-interest investments weakens further.

Yet few investors are buying it.

Instead, the march out of the stock market continues, with almost half of the R789bn in local collective investment schemes invested in fixed interest unit trust funds at the end of the second quarter.

Only 23% was invested directly in equity funds, according to data from the Association for Savings and Investment SA (Asisa).

Despite shares beating returns on cash comfortably for the year to end-June, investors are choosing the safety of bank accounts and fixed-interest funds.

Funds invested in the money market have attracted particular interest, with a net R7.7bn inflow of investor money in the year to end-June. (Money market vehicles invest in short-term debt instruments and bonds. Basically your money is lent to government and other institutions, which pay back the amount plus a fixed interest rate.)

A further rate cut will make money market funds even more attractive when compared to banks' call accounts, according to Lisa MacLeod, fixed income portfolio manager at Investec Asset Management.

Money market funds are able to lock into higher-yielding instruments with a maturity of up to one year, while call account rates drop when the repo rate falls.

"Therefore, as interest rates come off, the spread between money market fund yields and cash rates invested on call accounts will widen, making money market funds far more appealing."

Over the last year the average money market fund outperformed the return of the average wholesale bank call deposit by over 0.70%.  

Also, money market rates do not depend on the amount invested. With banks' call accounts, the rates vary depending on the amount invested. A smaller investor (with for example R100 000 to invest) could earn up to 4% lower than an investment in a money market fund, MacLeod calculates.

Dangerous game

The steady returns of fixed-interest investments – and the reassurance that you won't lose any of your money – provide comfort to many amid global turbulence.

But there is growing concern that by playing it safe, many investors, particular older ones, are caught up in a dangerous game.

Consumers continue to believe that stock market volatility is the biggest enemy of their retirement capital, while it is actually inflation they need to fear, Leon Campher, CEO of the Association for Savings and Investment SA, recently said.

Inflation, and the effect of tax and costs, will easily whittle away the value of your investment.

Current money market rates on offer are about 5.5%, and long-term fixed-income rates are sitting at 7.2% – still beating the main CPIX inflation indicator (currently below 4%).

But while inflation should still stay below 6% this year, 2011 will be a different story, predicted Schalk Louw, executive chair of Contego Asset Management.

Above-inflation salary increases, next year's 25% eletricity price hike and higher commodity prices – oil jumped 9% over the past week – will probably stoke inflationary fires.

In a world in which inflation could become the primary concern over the long run, one of the asset classes of choice will be cheapish equities; especially those that have pricing power and hence can grow profits ahead of inflation and pay attractive dividends, said Shaun le Roux of Alphen Asset Mangement in a recent report.

"Real yields on domestic bonds look decidedly unattractive in any situation other than a very benign inflationary cycle, given the structural pressures on inflation in South Africa."

Louw expects the economy to enter a recovery phase in the next couple of months, which is usually accompanied by a big earnings boost.

After a hard couple of years, many companies are lean and mean, with costs cut to a minimum. Any uptick in sales will have a major impact on corporate bottom lines.

Commodity shares, which have been under immense pressure over recent months, look particularly appealing as prices start to climb, Louw says.

But he warns that the days of 40% returns in share investments are still far off. The market – at a current average price/earnings ratio of 16 times – does not look massively cheap at the moment and risks remain.

Still, while money market funds could be a safe place to park money for a year or two, investors with longer time frames should look at shares.

For all its histrionics, the JSE's All-share index has not suffered a loss for any rolling five-year period over the past century.

 - Fin24.com
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