asset classes Understanding Equities Property Bonds Cash

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1 NEWSLETTER Understanding asset classes High return Property FIND OUT MORE Equities FIND OUT MORE Bonds FIND OUT MORE Cash FIND OUT MORE Low risk High risk Asset classes are building blocks of any investment. Asset classes chosen by an investor depend on a number of factors, namely; risk tolerance, length of investment and your financial objectives. This series of fact sheets looks at the main asset classes: cash, bonds, property and equities.

2 FUNDamentals Asset Classes Typically investments are divided into four categories, known as asset classes: cash, bonds, property and equities. The different types of assets have different performance characteristics. These asset classes are discussed in detail in the pages that follow. Cash Cash includes money held on deposit (as with a bank or building society account) and also other money market securities which earn interest over time. It is normally considered to be a temporary haven during periods of market volatility, or in the run-up to your selected retirement date. However, the real value of the investment in cash may be eroded over time by the effects of inflation. Bonds Bonds are taken out by a company or a government over a fixed amount of time in return for a fixed interest rate as well as the return of the original capital. Different types of bonds have different levels of risk. Generally they are considered lower risk than shares or property. Property Commercial properties, such as offices and warehouses, which are bought and then leased out to create income from the rent charged. Property returns are generally lower than shares but can be higher than cash and fixed interest. Equities Equities also known as shares, and are issued by a company to raise money to develop the business. Investors buy shares, which can be traded on the stock market. They are considered one of the best investments to achieve good long-term returns, but can be quite volatile in the short term.

3 NEWSLETTER THE ASSET CLASS SERIES Understanding cash as an asset class Cash as an asset class has the lowest risk of losing capital but the highest risk of losing purchasing power due to inflation. There are several ways in which cash can be invested, other than just cash in the bank account. In this fact sheet we look at cash as an investment, the different types of cash investment, how investors should allocate their cash and whether or not investors can earn good returns from investing in cash.

4 What is cash? From an investment perspective, cash can mean several things including money in your bank account, money in a fixed deposit account or an investment in a money market fund. All these have cash as their underlying source. Cash and cash equivalents are short-term, readily accessible or maturing within one year, low-risk assets. Cash as an asset class has the lowest risk of losing capital but the highest risk of losing purchasing power due to inflation. Generally speaking, fixed-income securities with a maturity date of less than one year can be considered cash for the purposes of asset allocation. Types of cash investments Cash and cash equivalents are short-term, readily accessible or maturing within one year, low-risk assets. Fixed deposit account A fixed deposit account is a type of savings account where one deposits one s cash for a specified period of time in return for a fixed rate of interest, which is usually higher than one would receive from a normal bank account. Fixed deposit accounts typically require funds to be left in the account until the maturity date, possibly incurring penalties for early withdrawal. Money market account A money market account is a type of savings account, offered by banks, that provides a competitive interest rate, usually higher than one would get on a normal savings account, in exchange for larger-than-normal deposits. Some money market accounts place restrictions on the amount of transactions you can make in a month. Furthermore, one usually has to maintain a certain balance in the account to receive the higher rate of interest. Money market fund The purpose of a money market fund is to provide investors with a safe place to invest in a fund that is easily accessible. Money market funds are characterized as low-risk, low-return investments. Money market funds make their returns by purchasing short-term investments (investments maturing in less than one year) such as Treasury bills, short-term certificates of deposit (CDs), and short-term commercial debt.

5 Comparing a money market account and a money market fund Money market funds and money market accounts are both investment vehicles that can be used within the cash asset class within an investment portfolio. What then is the difference between these two types of investment? Firstly, looking at the comparisons between money market funds and money market accounts: Both usually invest in short-term, fixed income investments such as U.S. Treasuries. By definition, short-term, fixed income investments are those with maturities of less than one year. Both money market funds and money market accounts usually offer higher interest rates than traditional savings accounts due to the fact that the short-term investment instruments they invest in have the potential for higher returns. Both types of investments offer flexibility and liquidity, usually allowing investors to draw their cash from an ATM or using cheques. The one key difference is that a money market fund is a collective investment scheme (unit trust fund) and not a bank account. Similar to other types of unit trust funds like equity and bond funds, money market funds incur expenses, which are passed on to the fund s investors. Money market fund Money market account Investing in cash as an asset class There are several considerations for investors when deciding one s allocation to cash, either via a money market fund, money market account or other cash investments: 1. Investing in cash is suited to investors looking for stability over higher returns. 2. Cash is a low-risk investment, but is affected by inflation, therefore, one needs to consider the inflationary environment when investing and ensure that the returns earned from cash is beating inflation once the effect of tax and fees has been taken into account. 3. Due to the relatively low returns of cash, it is not often used as a long-term investment option. 4. Cash investments provide a good holding place for money that investors are looking to invest for the longer term, but haven t chosen the correct fund. 5. Almost all portfolios have a cash portion, the exact percentage of this portion compared to one s overall investment capital is determined based on an investor s investment objectives, in discussion with their financial adviser. 6. Cash is referred to as a defensive asset, together with fixed income (bonds). Its focus is on providing a stable, low risk return, or providing income for investors. 7. Cash is a fully liquid investment, which means that investors can withdraw their money at any time. 8. Unlike unit trust funds that are invested in equities that can go up and down in value, money market funds, which are also unit trust funds, aim to have a constant net-asset value (NAV) of R1. This means that they aim to never lose money so that investors will always get their original invested capital back. The returns from a money market fund is known as yield and this is effectively the interest rate paid to investors on their invested capital. Although fund managers attempt to keep money market funds NAV at R1 there is no guarantee that it will remain at this price. 9. Money market fund rates are variable, which means that they can change on a monthly basis depending on the performance of the underlying investments. Therefore, the yield paid to investors can differ from month to month. 10. All leading fund managers in South Africa offer money market funds for investors to choose from.

6 Efficient Frontier Ranking Please remember there are no guarantees with any asset classes. The graph below is for illustrative purposes only. High return Low return Low risk Cash Bonds Property Equity High risk Cash is the least risky asset class, which provides consistent low-risk, low-volatility returns. Cash is not expected to produce high returns such as for equities. Discovery Invest offers investors numerous cash options including money market funds from which to choose when considering a stable return for their investment portfolio. Discovery Invest s Fund magazine provides full information on available funds. Investors are advised to speak to their financial adviser when choosing money market funds, or other cash alternatives, for their investment portfolio. Note: We have other fact sheets that discuss Property, Equities and Bonds which may be of great interest to you.

7 NEWSLETTER THE ASSET CLASS SERIES Understanding bonds as an asset class A bond allows companies or governments to borrow money today and pay it back in the future. Bonds are what we refer to as debt investments. Bonds like a loan, allow companies and government to borrow money today and pay it back in the future. In this fact sheet we explore what is meant by bonds, the different types of bonds and how the different entities earn returns by giving bonds.

8 What are bonds? A bond is a loan. Similar to normal credit given to individuals, a bond allows companies or governments to borrow money today and pay it back in the future. The pay back date (also called the maturity date) and the agreed interest rate are carefully spelled out in a legal document. By buying corporate or government bonds, individuals are lending money to those entities in return for regular interest payments and the return of their capital on the maturity date. Bonds are also referred to as debt investments or fixed income investments. The different types of bonds There are several types of bonds, depending on whether a company, government or municipality are issuing the bonds, these include: Government or Treasury Bonds Government bonds are issued by governments on behalf of the respective country e.g. United States, United Kingdom, Germany, South Africa, Australia etc. Almost all countries offer government or treasury bonds to investors. Government bonds are generally considered the safest debt because it is backed by the faith and credit of the country repaying the loan. Although it can happen, it is extremely rare for countries to default on government bonds, even those experiencing political and economic turmoil. Corporate Bonds Corporate bonds are issued by companies and are guaranteed by the borrowing company i.e. the company issuing the bonds. The risk depends on the company s ability to pay the loan at maturity. Therefore, investors are exposed to credit risk of the company they are investing into. Municipal Bonds Municipal bonds are issued by local governments and agencies, and are sometimes subject to certain tax preferences, such as being exempt from local taxes.

9 Investing in bond funds A bond fund is a collective investment scheme that invests in various underlying bonds and debt instruments. The exact type of debt the fund invests into will depend on its focus, but investments may include government, corporate, municipal and convertible bonds. Bond funds are often referred to as fixed income funds. Bond funds typically pay periodic dividends that include interest payments on the fund s underlying bond holdings plus periodic realised capital appreciation. Bond funds typically pay higher dividends than money market accounts and most bond funds pay out dividends more frequently than bonds bought individually by investors. Bond funds are typically suited to investors looking for a low-risk investment and wanting to earn a monthly income from their portfolio. As such, many individuals approaching retirement, or in their retirement years, choose bond funds or fixed income funds as part of their portfolio. Advantages of bond funds include: Higher interest rates paid to investors than money market funds and bank accounts. Diversification of the underlying assets in the portfolio as a range of bonds are held within a single portfolio. Professional management of the fund, maturity dates and trading of the bonds. Ease of investment as one only needs to invest in a single fund and not a range of individual bonds in order to get diversification and access to different bonds. Efficient Frontier Ranking Please remember there are no guarantees with any asset classes. The graph below is for illustrative purposes only. High return Low return Low risk Cash Bonds Property Equity High risk Bonds or fixed interest is a relatively low risk asset class. It produces anticipated returns lower than equity and property but higher than cash. Investors are advised to speak to their financial adviser about the different bond funds or fixed income funds available in South Africa and choosing the best approach for their individual needs. Discovery Invest offers a number of low-risk fixed income funds for investors approaching retirement and those already in their retirement years. Note: We have other fact sheets that discuss Property, Equities and Cash which may be of great interest to you.

10 NEWSLETTER THE ASSET CLASS SERIES Understanding property as an asset class Property as an asset class offers diversification, it offers different performance characteristics and low correlation. There are several ways for investors to gain exposure to property within their investment portfolios. This fact sheet examines property as an asset class and explores the investment options one has when allocating a portion of one s portfolio to this investment class.

11 FUNDamentals Different property investment options DIRECT INVESTMENT Direct investment in property is usually made through the purchase of residential, industrial, commercial or retail property, such as buying a residential house or apartment and renting it out, or buying an office block and renting out office space. Investors can benefit from regular rental income as well as capital growth on the property over the long term. However, investors have to be certain about the earning potential of the property. An over-speculated property market has left many properties empty without residential or business tenants. Listed Property Shares There are a number of companies on the stock market which only invest in property. Investors can choose to buy stocks in these companies that in turn manage a portfolio of properties across various sectors of the economy, including retail, office and industrial properties. If choosing to invest in listed property shares, investors should be aware that property stocks are primarily exposed to the commercial property market including shopping centres, offices and industrial buildings, therefore, trends in terms of rental increases and the availability of commercial tenants can affect the performance of listed property shares. Property Unit Trust Funds One of the most common ways of accessing property investments for retail investors is through property unit trust funds. These dedicated unit trust funds are exposed to a large range of properties, usually of higher quality than one would access as a direct investor. Property unit trusts are managed by asset management companies such as Allan Gray, Coronation, Investec etc. This means that the professional investment expertise of these companies is applied to the management of the property unit trust. The advantage for investors is that one knows that one s portfolio is being scrutinised for value and managed by a dedicated professional who can make informed decisions about the properties within the unit trust fund. Property Syndicates Property syndicates have proven to be highly risky investments for investors in recent years due to scandals such as Sharemax, where investors were lured by promises of high returns when in fact many investors lost most, or all, of their investment capital. Property syndicates can operate in various ways, one of them being by buying a portfolio of properties and selling a share to interested investors as well as charging a fee for managing the properties. Unfortunately, the syndication market has been hit by numerous scandals with properties being overvalued and in some cases outright fraud, which has left many investors ruined financially.

12 FUNDamentals Comparing property investments Type of investment Advantages Disadvantages Direct investment Listed property shares Property unit trust funds Property syndicates Regular rental income and capital growth on the physical property over the long term. Access to property through listed shares, which indicates a higher quality range of properties. Managed by reputable asset management companies. Professional expertise are applied to managing the portfolio and choosing high quality properties. Investors do not need to worry about the management of the underlying properties. An over-speculated property market has left many residential and business properties empty. Investor has to manage the property them self or pay an agent to manage the property on their behalf. Listed property shares are mostly exposed to the commercial property market with very small access to the residential property market, so the performance of the shares is dependent on the performance of the commercial property market. Fees can be higher than other unit trust funds due to the higher cost of buying and managing property. Investors have been misled by promises of unrealistically high returns. Not regulated and have been marred by property scandals where investors have lost most or all of their investment.

13 FUNDamentals Efficient Frontier Ranking Please remember there are no guarantees with any asset classes. The graph below is for illustrative purposes only. High return Equity Low return Low risk Property Bonds Cash High risk On the efficient frontier, property as an asset class is Bonds between or equities fixed and interest fixed assets is a (or relatively bonds). low Property risk asset produces class. It produces higher expected anticipated returns returns than bonds lower with than more equity risk than and bonds, property but but less higher than equities. than cash. Before making any investment decisions, investors are advised to speak to their financial adviser who can guide them on the different types of property investments available and assist them in choosing the investment that is most suitable for their circumstances and personal financial planning objectives. Note: We have other fact sheets that discuss Cash, Equities and Bonds which may be of great interest to you.

14 NEWSLETTER THE ASSET CLASS SERIES Understanding equities as an asset class A share of stock is the smallest unit of ownership in a company. If one owns a share of a company stock, one is effectively a part owner of the company. Equities allow investors to trade on the stock exchange, they often have the highest returns. In this fact sheet we explore the different types of equities that can be sold and bought on stock exchanges, as well as the different funds that one can invest into.

15 FUNDamentals What are equities? Equities are another way to describe company stocks that are bought and sold by investors on stock exchanges. In order to sell stock to investors, companies must be listed on a stock exchange. Different types of equities There are different types of stocks based on different companies listed on the stock exchange, which can broadly be categorised as follows: Large-capitalisation Stocks or Large Cap Stocks These are stocks of large, established companies that fall within the top 40 largest companies, by market capitalisation, listed on the FTSE/JSE All Share Index. Middle Capitalisation Stocks or Mid Cap Stocks These are stocks of medium-sized companies those that fall just behind large cap stocks in terms of market capitalisation, and are listed on the FTSE/JSE All Share Index. A share of stock is the smallest unit of ownership in a company. If one owns a share of a company s stock, one is effectively a part owner of the company. Small Capitalisation Stocks or Small Cap Stocks These are stocks of small companies, with a market capitalisation less than R5 billion, listed on the FTSE/JSE All Share Index. Small cap stocks are not traded as often as mid and large cap stocks therefore information available for investors on these companies can be relatively limited. Some unit trust funds focus specifically on small cap stocks as a source of high growth and high returns in investment portfolios. A share of stock is the smallest unit of ownership in a company. If one owns a share of a company s stock, one is effectively a part owner of the company, which entitles you to dividend payments, to attend the company s annual general meeting and to vote on matters relating to the company. The more company stock one owns, the greater one s power in terms of voting. Company stocks are typically highly liquid and trade daily creating an opportunity to buy or sell shares almost any day that the markets are open. Some of the largest buyers and sellers of company stock are portfolio managers who manage collective investment schemes and other funds on behalf of investors and who research a vast range of companies, across many sectors to determine the companies that they feel will grow in value, thereby, making their stock more valuable.

16 Investing in equity funds An equity fund is a collective investment scheme that invests primarily in stocks. Equity funds can be actively or passively managed. Actively managed equity funds are managed by a portfolio manager who will typically choose a specific focus for the fund, for example: Growth funds These funds invest for maximum capital appreciation by buying stock in growth companies. Growth companies are defined as those whose earnings are on an upward trend, or whose earnings are anticipated to be on an upward trend. Value funds Value-orientated funds search for value companies by investing in shares that have an anticipated higher earning potential than their current stock valuation. Value funds aim for medium- to long-term capital appreciation and frequently offer a higher than average level of income. General funds General equity funds invest in selected shares across all industry sectors of the FTSE/JSE All Share Index, as well as across the range of large, mid and smaller cap shares. General funds do not subscribe to a particular theme or investment style and could consist of both value and growth shares. Mining and resources funds These funds aim to achieve capital appreciation by investing in shares of companies involved in the exploration, mining, distribution and processing of metals, minerals, energy, chemicals, forestry or other commodities. Financial and industrial funds These funds invest in banks and other companies that operate in financial services and the industrial sector. Some funds have a more concentrated approach and invest only in the finance sector, or in the industrial sector.

17 Quick reference glossary Dividends a share of a company s profits passed onto shareholders on a periodic basis. Stock market the market in which shares are bought and sold through exchanges. Also known as the equity market, it is one of the most vital areas of a market economy as it provides companies with access to capital and investors with part ownership in the company and the potential for gains based on the company s future performance. Market capitalisation a company s market capitalisation or market cap is used to determine the company s size in a given market. Market cap is calculated by multiplying a company s unsold stock by its current market stock price. Liquid if a stock is liquid, it means that it can be easily bought and sold on the stock exchange. Efficient Frontier Ranking Please remember there are no guarantees with any asset classes. The graph below is for illustrative purposes only. High return Low return Low risk Cash Bonds Property Equity High risk On the efficient frontier, equities are the highest risk asset classes but also have the potential for the highest returns. Discovery Invest offers investors numerous equity funds from which to choose when considering growth for the investment portfolio. Discovery Invest s Fund magazine provides full information on available funds. Investors are advised to speak to their financial adviser when choosing equity funds for their investment portfolio. Note: We have other fact sheets that discuss Property, Cash and Bonds which may be of great interest to you.