No investment is free of risk.
Equally, no investment is to be avoided at all costs because it is risky.
Once investors know what kind of risks they can bear and whether they have the knowledge to invest in seemingly higher risk investments, the choices become a lot easier.
As uncertainty and volatility have escalated in recent years, there has been a constant call on investors to diversify and avoid high risk investments. But typically most portfolios have, and need, an element of risk says Gavin Smith, Head of Africa at financial advisory group, deVere Acuma.
“All investment involves some risk. Even so called ‘risk-free’ assets, such as U.S. Treasuries (American government bonds), are vulnerable to inflation which whittles down the real value of the Treasury note.
“Bank account cash is also vulnerable to inflation, and to the very small risk of the bank being unable to repay,” says Mr Smith.
But because these are relatively small risks, we don’t think of them as ‘risk assets’ – a term generally used to describe equities and high yield bonds, where the risk of losing some or all of your capital is higher than if you hold core government bonds or cash.
South African investors may feel they are exposed to an abnormally high level of risk. Generally, the bulk of their investments are local, with an inherent exposure to emerging market and currency risks. With increased political uncertainty, there is also a level of political risk in South African investments.
Additionally, a “home bias” may result in a high level of exposure to mining and resources shares as these are a significant part of the local economy and South African investors feel they have an understanding of them.
Tom Elliott, deVere’s international investment strategist, says that during times of stress on global stock markets we tend to see a high correlation amongst emerging stock markets as professional investors sell the asset class indiscriminately and buy safer assets such as Treasuries. “This can give the impression that all emerging market stock markets move in line with one another. But this rare, and a look at the data during such periods will always reveal relative winners and losers.”
“This suggests that a South African investor can achieve diversification through investing in other emerging market stock markets, either through buying regional funds (specialising in Asia or Latin America, for example), or through buying an active global emerging market fund and paying the fund manager to invest in the countries and regions with the best potential for growth.”
As far as resources investments are concerned, Elliott says precious metals have room in all investors’ portfolios as a hedge against inflation and as a play on growing demand in the case of certain metals. “Most fund managers wishing to include them might have a 4% to 6% weighting,” he says.
“While holding metals won’t deliver an income, mining shares will and because they are easily tradable tend to be a better way of gaining exposure to metals.” The drawback, however, is that the investor is then exposed to company-specific risk. Smith warns South African investors to guard against over-exposure to precious metals simply because South Africa is a major producer of them. “This home bias can detract us from achieving a truly diversified portfolio.”
For the majority of investors, the best option is to have the bulk of their investments in funds, where diversification decreases individual stock risk. They can then focus on choosing the most suitable asset class (ie, choosing between equities and bonds, and between regions or sectors within those asset classes). Investors can also choose between active funds, where fund managers try to outperform a benchmark index, or funds that passively track the benchmark index – both types of funds have room in a diversified portfolio.
A smaller part of a portfolio could be in individual stocks that investors believe will outperform, “but we must be cautious and recognise our own limitations,” says Elliott. “We don’t have access to the same level of information on individual companies as a professional fund manager does, we may not know how to use the information even if we did and few of us have the time to actively manage individual stocks.”
“Futures and derivatives are used by experienced investors to both reduce and increase the risk/return profile of a portfolio, but require a technical knowledge beyond that of many private investors,” he shares.
He warns investors to “never, ever, buy an individual stock or derivative from a cold-call on the telephone”.
deVere sees human behaviour as the biggest risk to accumulating investment returns. “We tend to trade too much, and buy high and sell low. It takes discipline to stick to a particular investment strategy and to avoid herd behaviour.”
But we will always, and indeed should, take on a certain element of risk. “The tendency over time for equities to outperform bonds, and for bonds to outperform cash, does demonstrate that it pays to take on some degree of risk,” says Smith.
It also demonstrates that it is best to have a long-term perspective, he says, and not sell equities after a stock market dip, and miss out on the recovery.
Whether volatile markets mean that investors should look for stability or try to take advantage of the volatility comes down to individual risk profiles and investment horizons.
No investment is free of risk. Equally, no investment is to be avoided at all costs because it is risky. Once investors know what kind of risks they can bear and whether they have the knowledge to invest in seemingly higher risk investments, the choices become a lot easier.
Gavin Smith, Head of Africa, deVere Acuma
About deVere Acuma
One of the world’s leading financial advisories, deVere Acuma provides South African residents with trusted, expert and bespoke financial advice. Licenced and regulated by the Financial Services Board, deVere Acuma has been operational since 2008 and has offices in Johannesburg, Cape Town and Durban. Its comprehensive range of tailored financial planning servicesand products, and market-leading technologies offer investors a number of benefits.
deVere Acuma forms part of the deVere Group, one of the world’s largest independent advisors of specialist global financial solutions to international, local mass affluent and high-net-worth clients. The group has a network of more than 70 offices across the world, over 80 000 clients and US$10 billion under advisement. Being part of the deVere Group, gives deVere Acuma a strategic vantage point to offer its clients unrivalled market knowledge and financial planning solutions that are available exclusively to deVere clients.