Should investors be concerned about short- and medium-term volatility and returns?

1 Dec 2016

Adriaan Pask, Chief Investment Officer, PSG Wealth

 South Africa multi-asset high equity portfolios attracted net annual inflows of R16.5 billion to the end of the third quarter of 2016. General equity portfolios recorded net annual inflows of R3.2 billion over a similar period. This is according to collective investment schemes (CIS) statistics for the quarter and year ending June 2016 released by the Association for Savings and Investment South Africa (ASISA). A senior policy adviser at ASISA, Sunette Mulder, says that most investors, and their advisers, have opted for a portfolio that offers similar returns to a general equity portfolio but with a more diversified risk profile to reduce volatility over the short and medium term.

 Investing is a long-term commitment

 Equities have proved time and time again that as an asset class they deliver the highest returns over the long term. So, if investors truly believe the principle that equity investments are long-term commitments, should they be concerned about short- and medium-term volatility or corrections?

An analysis of the long-term returns of equities (from 31 January 1960 to 30 September 2016) has revealed that the FTSE/JSE All Share Index (ALSI) recorded a nominal return (not adjusted for inflation) of 11.97% per annum.

If the index is adjusted for inflation over this 56-year period, then real returns drop to 3.60% per annum. Interestingly, this correlates to the long-term real economic growth of South Africa. The 8.09% difference between the nominal return and the real return is our long-term inflation rate.

If an investor also reinvested dividends earned, the long-term total return of the index jumps to 16.88% – an additional return of 4.38%. Equities can deliver a real return of inflation plus 3.60%, without the reinvestment of dividends. When the dividends are reinvested, equities could offer a real return of 8.14% over the long term. This shows that equities, without any doubt, is the only asset class that can beat inflation at this rate.

 Equities have the highest potential to create wealth

 The risk of an investment in equities is generally associated with higher volatility present in markets. Volatility, however, is influenced by both the upside, and the downside movement in values. One needs to consider the potential of negative returns to assess the real risks inherent in an investment in equities.

 Equity remains the asset class with the highest potential to create wealth. It is, however, a risky investment with the potential for large losses in capital over the short term. These risks are easily reduced, and eventually negated, if the investment horizon increases to more than five years.

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