The see-saw effect between the performance of local shares and foreign equities over the past quarter to end-June perfectly underlines the importance of diversification. Spreading risk is not a sexy subject: but the investor who is serious about long-term wealth creation simply cannot ignore the benefits and basic good sense of diversification.
All it really means is spreading your money around a little so that you don’t take a big hit if one particular asset class, or equity sector, underperforms badly. On the simplest level this can be achieved, to an extent, by investing in a decent general equity fund. Not necessarily the fund that came out top last quarter but one that has consistently been placed near the top, say the top 10 or 20, for at least a year or longer.
It also means avoiding the stampede of the herd, and this is where the latest unit trust results illustrate the point. Take Mrs Jones, for instance. Her friend Marge told her at a New Year’s Eve party of the wonderful returns she’d been earning on her rand-denominated foreign equity unit trust fund. These were largely thanks to the depreciation of the rand last year.
Most of the rand-denominated foreign funds have closed to new business, but on the first trading day of the year Mrs Jones found one that still had capacity and ploughed all her spare cash into it. You know the rest of the story — equities in most developed foreign markets have hit lows not seen in years and to top it all the rand has retraced most of the ground it lost last year. Mrs Jones has decided that unit trusts are just a big casino, has withdrawn the little cash left in the fund, and was last seen heading for Turffontein race track.
Mrs Modise was at the same party but decided to split her money between a foreign fund and local general equity fund. Her foreign money has taken a knock, but has been covered to a large extent by the performance of the local unit trust. Mrs Modise is not too concerned at the performance of the offshore investment, knowing these things work in cycles. In fact she’s putting more money into foreign equities on a monthly basis, realising that the lower prices go the more units she’s buying for the same monthly amount.
When foreign markets recover, which should support the relatively strong performance of the JSE Johannesburg Securities Exchange so far this year, Mrs Modise could be sitting pretty in a few years’ time.
The simple story is don’t pull out of foreign equities now — it may even be a good time to start trickling money into a foreign fund. And don’t commit the house to the local market either, despite fairly upbeat forecasts for the year ahead. That could change. Rather enjoy the benefits of both, maybe tilting your investments towards one or the other if you have a strong view — but at all times remain diversified.
The dangers of going overboard locally are demonstrated by a simple statistic. Over the past year what is now called the FTSE/JSE All Share Index has gained 19,2%. Against average inflation of about 9% for the same period that’s a return of 10%, not bad in anybody’s books. But take resource shares out of that, which have been the top specialist unit trust funds for the past quarter, year, three years and maybe longer, and the All Share Index actually lost 5,2% over the year.
The hazards are obvious. Resource stocks still look good for a while, but if that changes the performance of the whole market will look very different owing to the large weightings attached to these shares.
Investors in domestic general equity funds, which according to figures from the Association of Unit Trusts put on an average 10,8% over the year, will have some protection from this. Just as they get limited upside from resource shares, they will also be protected on the downside should resource stocks collapse.
But more adventurous investors will look for something to tweak returns, and intelligent diversification can do this. Say Mrs Modise split the foreign portion of her investment between global equities and bonds. The equities have lost, on average, about 19% since the beginning of the year, the bonds around 9%. That’s still a double negative, but better than losing a full 19%. Go back a year and the foreign equities were up 9%, the bonds 37%. With global developed-country interest rates and inflation at rock bottom conditions remain good for bonds, but as equity prices start to recover Mrs Modise will gradually shift money from bonds to equities.
Where should the smart fringe money be going in the local market? General equity funds aren’t a bad bet, some have performed excellently. Mention must be made of the Oasis Crescent Equity Fund, which has grown investors’ money by 30% over the past year and also leads the tables over two and three years.
Other leading funds, however, are starting to take defining views. John Biccard runs the Investec Value Fund, a top performer in its sector for as long as you care to mention with a return over the past year of 39%. He takes the inspiring outlook that small- and middle-sized local companies offer the best value at the moment, and the shares have performed better than the market over the past few months. Financial shares have disappointed, but Biccard thinks they are cheap and is investing. He’s ignoring resources, a tentative sign, perhaps, that it may be time to get out.
His colleague Clyde Rossouw manages the more gung-ho Investec Growth Fund (up 17% over the year), which is still invested in resources, particularly Anglo American and Impala Platinum. He also has a large exposure to Remgro and is putting more money into banks, especially Nedcor.
My rearranged portfolio from three months ago has been mixed. I blew it on tech funds but have left the money where it is — if the world survives this century technology must come back, but this may take some time. Financials have disappointed too, but I’m committed, if for no other reason than the major local bank and insurance shares are looking too cheap.
Where I have got it right is small caps, up an average 9% over the past three months and looking good going forward. My portfolio is diversified through a few solid, if dull, local and foreign general equity funds.
But my really fringe view is on the rising sun — take a look at Old Mutual’s Japan fund-of-funds for an interesting outside bet.