JOHANNESBURG - A good friend of mine, let me call him Mr X - a highly respected and astute investor - regularly throws questions at me regarding the outlook for financial markets, economies and threats and opportunities. I thought I would share my answers in the wake of us suffering from bad year blues.
What is the goal of investment? (To grow wealth in real terms?)
It is all about what your specific life goals are. Growing wealth is to increase the purchasing power of your savings over time. Yes, everybody wants to be rich or at least live a comfortable life or retire without any financial worries.
The question is how do you reach your specific life goals? You need money to make money, so if you do not have money you should start saving. History has shown that investment in growth assets such as equities, and even real estate, over time increases the purchasing power of savings, while cash or near cash such as bank deposits hardly maintain the purchasing power of savings.
What is the ideal investment period?
I am not a financial adviser, just a poor analyst and scholar of the investment industry. I am guided by the combination of four basic questions when it comes to the ideal investment period as it concerns the optimal asset mix for you as investor.
The first question is, how much risk are you willing to take - risk in the sense of how much are you willing to lose on your total investment?
We have seen that growth assets such as equities, as measured by share indices such as the all share index, at some stage fall by more than 40 percent in recent years.
Second, how long are you prepared to wait to recover your losses, as it can take up to five to seven years to recover?
Third, what is your exposure to risky assets such as equities in your overall scheme of things - yes, your total assets?
If your exposure to risk assets is high, you and your adviser should think about it carefully.
If it is small and you have enough other assets, for example lifestyle assets such as holiday homes, etc, that you can liquidate over time, you can probably afford the risk.
Fourth, to what extent are you dependent on the income from your total assets and free-to-invest or investment portfolios, including retirement funds? If you are highly dependent on this income, then it is vital to ensure your financial health.
Call deposits carry very little risk, but at best you will maintain the purchasing power of your investment. Long-term interest-bearing investments such as government bonds offer inflation-beating returns, but carry higher risk than call deposits as they are subject to risk factors such as a country's risk rating and even possible debt defaults.
Listed property offers inflation-beating income yields, income growth and has some of the characteristics of equities, but are highly geared to long-term interest rates and thus more risky than long-term government bonds. Listed equities, both locally and globally, carry the highest risk.
So, basically your investment period is effectively infinite. It is all about the structure of your total investment portfolio, which addresses your needs, financial health and wealth - which may change over time.
Have South African investors succeeded in meeting their goals over the past few years?
I am a great believer in Nobel laureate Robert Shiller’s cyclically adjusted PE ratio, or PE10, and use his methodology to estimate the PE10s for developed market equities (MSCI World Index in US$) and the all share index.
According to my estimates the average PE10 of the MSCI World Index in US$ since 2013 (when the previous bull market started in earnest) is 21. Since November last year the index was trading at a premium to the average and ended the third quarter of this year on 24.
Now it is back on 21 - yes, smack-bang on the average. In contrast and mainly due to domestic issues - whatever the cause may be - the JSE’s average PE10 since 2013 is 19 and the last time it traded close to that level was in January this year and it is currently sitting at 16.
Remember, you got used to the JSE returning more than 18 percent a year over the five years from the end of 2008 until the end of 2014 and expected the great returns to continue. As an educated investor you were fortunate to invest some of your funds abroad.
How will you allocate funds between South Africa and foreign markets?
Again, it comes back to your optimal asset mix. My analysis of the asset mix combinations that produce the most efficient returns per unit of risk indicate that your optimal asset mix should consist of an offshore component of more than 20 percent of your assets. It is the same for your grandma, who is dependent on income and capital preservation.
In which foreign markets and asset classes will you now invest?
I prefer emerging markets in Asia. The iShares MSCI Emerging Markets Asia ETF is trading at a P/E ratio of 11.8 compared to the 17.5 times earnings offered by developed market equities as measured by the iShares MSCI World ETF, while on a Price/Book ratio the former is on 1.5 times compared to the latter's 2.3 times.
On the fixed interest side, US medium-term government bonds are on my radar screen.
Where will you invest the funds allocated to South Africa?
Bombed-out financial and industrial equities as well as listed real estate and long-term government bonds.
What is your favourite investment quote/truism?
If everyone's thinking alike then no one is thinking - Benjamin Franklin.
Ryk de Klerk is an independent analyst. Contact [email protected] His views expressed above are his own. You should consult your broker and/or investment adviser for advice.