Jan 10

Choose Your Investments Wisely!

An Article By Ian Kilbride published on 9 January 2024 in Skyways Magazine.

You can have too much of a good thing. This well-worn phrase applies to the wide choice available to individual investments. Choice is a good thing of course and is the essence of individual freedom, but can also lead to confusion and costly mistakes. So, it’s vitally important to understand the choices available and their risks when making investment decisions.

As the names suggests, balanced funds and unit trusts invest across all the major asset classes, namely, shares, fixed income securities (such as bonds) and cash. The idea behind a balanced fund or unit trust is that risk is reduced by not putting all your investment eggs in one basket. So, for example, if shares (otherwise known as equities) are under pressure and interest rates are high, the balanced fund has the flexibility to invest more in cash and bonds in order to produce a better return. Conversely, if there is a bull market and shares are booming, the fund can invest its cash, liquidate its fixed income holdings and invest more in shares to ride the bull market.

At the opposite end of the spectrum are pure equity funds and pure fixed income funds which invest almost all of their investments in shares and fixed income instruments, such as government bonds, respectively. There is nothing inherently wrong in either of these types of funds and unit trusts, but the investor needs to be aware of the risks attached to investing in one asset class, the mandate of the fund and the benchmark the fund is measured against.

Equity funds can be further divided into those that invest almost exclusively in certain sectors and industries, such as the gold sector or resources, whereas others, for example, only invest in a basket of smaller companies, i.e., those with a smaller market capitalisation.

Globally, an awareness of and sensitivity to environmental, social and governance (ESG) issues is growing and consequentially we are seeing more and more companies reporting on these issues. These companies can attract a premium for having a good ESG scorecard and conversely, others such as polluters are coming under pressure and being shunned by some investors. This has propelled the formation of many more ESG funds and green funds that provide investors with the choice of participating in environmentally sustainable companies and ‘green bonds’. These funds and unit trusts form part of the basket of funds known as ethical funds and have a particular appeal to investors, institutions and pension funds who have a mandate to invest in sustainable and responsible companies only.  The same principle and philosophy applies to funds that are managed with religious considerations and prohibit certain types of investments such as in gambling or alcohol.

Another factor to consider is whether the fund or unit trust has exposure to international investments, or is a purely local, SA-based fund. While South Africa has some fabulous, world-class companies that would not be out of place in any investment portfolio, due to the limited number of companies listed in the JSE, many believe it is wise to be invested in a fund with maximum permissible exposure to international markets.

A further option available to investors is a wrap fund, which is an administrative structure that allows the fund manager to combine a number of unit trusts together in order to achieve a specific mandate and to suit the risk profile of the client. Each wrap fund will have a particular weighting of the selected individual unit trusts in order to achieve the specific mandate. For example, wrap funds can be constructed to achieve an aggressive, moderate or conservative risk profile. Closely related to this, a fund of funds is a legal entity in which the pooled funds invest in individual funds in order to achieve a desired diversification, appropriate asset allocation and thus, investment outcome.

But perhaps the most exciting and least understood individual investment options are being developed through financial technology and artificial intelligence. For example, financial algorithms are being written and programmed to identify and selected the best performing funds and to direct the private investors’ money into these top performing unit trusts in order to outperform and achieve a specific risk profile and investment objective. It’s still early days, but the indications are promising that fintech and applied artificial intelligence hold great potential for the private investor.

But if all of this has stimulated you to consider this smorgasbord of investment choice, then equally, the range of options should remind one of the importance of consulting a qualified and authorised specialist investment advisor before taking the plunge.