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By Ilana Sickle, 2 August 2016
No one can be certain what markets will do going forward or what returns will be like for various asset classes in 2016. What one can be certain about, is that with heightened political and economic uncertainty driving market sentiment we are sure to experience further volatility. On 24 June 2016 we experienced one such event with Britain voting to leave the European Union. We saw Britain’s main exchange, the FTSE 100 lose 3.15% by close of the session and a further 2.55% the following day. There are many other factors that will move our markets in the months to come with the implications of Brexit still unclear and China still a concern.
Locally, we are currently experiencing the effects of the worst drought in more than a century and this will have knock-on effects especially in terms of growth and inflation. While we were given a reprieve by the ratings agencies in June, the risks of a downgrade still remain, especially with local government elections looming and more recently the growth outlook for 2016 being cut to 0.1% from 0.6% by the International Monetary Fund.
With all the data releases and news flow skewed to the negative, it is no wonder investors are becoming increasingly more skittish and flocking to “safe-haven” assets such as gold and cash.
During the first three months of 2016 we saw quite a bit of volatility in the markets with investors acting in response to this. Looking at the first quarter ASISA statistics we can see that while the trend of moving into multi-asset class funds continues, approximately 23% of net inflows went to the money market category. At the other end most of the net outflows were from the more risky asset class categories such as equity and property.
In 2015, BlackRock conducted their Annual Global Investor Pulse Survey where respondents admitted to holding a far too high allocation to cash. In assessing the reasons behind this, they had the following to say:
We can therefore see that investors either stay in cash for security or switch because they are afraid of losses.
In behavioural finance there is a bias called loss aversion which relates to an investor’s preference to avoid losses rather than making gains. Many studies suggest that the pain derived from market losses impacts an investor twice as much as the pleasure felt from making gains. During corrections and market crises investors who are in the market tend to experience significant losses. These experiences impact them going forward during times of volatility. When there are indications that markets may correct, investors mitigate their potential losses by moving to less risky assets. In essence they are trying to time the market.
However, this strategy does not come without its potential downside. An investor moving to cash may, and often does, miss the upside when markets rebound. Research conducted by Fidelity shows how the impact of missing the best trading days significantly impacts the value of the investment.
Timing the market is definitely not the easiest strategy as you have to be right twice – when to switch to cash and when to move back into growth assets. The chance of being bitten twice is more probable than being right twice.
It is thus vitally important for investors to understand the potential impact of their decision. The diagram below shows the probable pleasure and pain of either staying invested or moving to cash.
An investor who moves to cash may therefore either avoid making losses or potentially miss out on the recovery.
A few considerations one has to bear in mind are the investor’s long-term goals, inflation, capital gains tax (CGT) liabilities and the alternatives. While these considerations are noteworthy, the most important consideration remains the investor’s financial objectives and risk tolerance.
When holding or investing in cash, the holding period is vitally important. Looking at the calendar returns since 2006 one can see that during each year different asset classes were the winners or losers depending how the markets performed.
However, if one looks at returns over various trailing periods, cash has typically not been the best yielding asset class over the longer term.
When holding cash, inflation is key, as this determines the real return earned. If we look at the one-year rolling return graph of cash against inflation since 2008, we can see that even though cash will more likely than not yield a positive return, it may not always deliver a real return.
While inflation has moderated over April and May, the consensus forecast remains that it should increase in the months ahead, with a main driver amongst others being higher food prices due to the drought. Some economists suggest that inflation will breach 7% by the end of 2016. It is important to be cognisant of these inflationary risks should the cash be invested for an indefinite period as it could result in a negative real return.
Before switching to cash it is worthwhile to establish whether a CGT event will be triggered i.e. will the realised investment value be greater than the base cost. Government increased the inclusion rate for individuals from 33.3% to 40% from 1 March 2016. This has raised the maximum effective CGT rate for individuals from 13.7% to 16.4% with an annual exclusion of R40,000 applying to all natural persons and special trusts.
However, in some instances switching to cash may also result in the investor realising losses. Often these losses may have been recouped faster during a subsequent recovery than moving to cash.
To illustrate this, we assume two scenarios where an investor invested R1,000,000 on 1 January 2015 and:
On 5 January 2015 the largest one-day drop of the year was experienced on the JSE where the All Share declined 3.41%. From the table below it is evident that despite the equity investment dropping significantly it took fewer days for the investment to return to its initial value relative to the money market investment breaking even.
As we know it is difficult, and near impossible to time the market. Unfortunately investors often sell in a panic after large declines. Now if we assume the investor switched after the decline, the number of days to breakeven for the money market investment increases to 228 trading days.
In the past few years there has been a proliferation of multi-asset funds and a general trend of flows into these categories. While a major driver of this trend is that these funds are generally Regulation 28 compliant, another is the fact that investing in these funds removes the strategic and tactical asset allocation decision from the intermediary and investor as it is left in the hands of the fund managers. The investor obtains all the benefits of diversification between asset classes in a single fund or by blending a few of these funds in line with the client’s risk profile. In addition the investor also benefits from the various managers’ tactical asset allocation views without incurring a CGT liability. These are the main reasons Glacier Research prefers the multi-asset fund approach. As seen in the below graph, in times of high volatility (indicated by the volatility indices line graphs), the managers actively allocate between asset classes. Hence, it is also important to carefully evaluate switching from multi-asset funds to cash as this may overly de-risk a portfolio when the fund manager is simultaneously moving into cash.
Many investors are currently sitting with cash in the bank - in vehicles such as current accounts or fixed deposits - for the same reason as those wanting to switch to cash. This “strategy” may, however, not be ideal for the following reasons:
Glacier recently launched the Glacier Cash Option. This is a cost-effective “parking facility” for new and existing clients wanting to delay entry to the market. Under this option, three funds are offered. Selecting either one or a combination thereof, will give the client a cash, or enhanced cash investment with the added benefit of Glacier’s partnership with Sanlam Alternative Investments. In addition, this team will advise Glacier as to when they believe the time is right to start moving into growth assets. No investment decision will be made on behalf of the investor, but rather communication will be sent to the intermediary and together, the intermediary and the client will then be in a better position to make an informed decision of whether or not to move out of cash. An added benefit of this product is the ease of administration as the funds are already on the platform with quick access to money, as opposed to fixed deposits where the money is locked into fixed periods.
We advocate the use of a blend of appropriate multi-asset funds where the asset allocation decision is removed from the intermediary or investor’s hands. We do, however, recognise that there are still investors who prefer using a building block approach to investing. These investors may currently be sitting in cash, waiting for the right time to invest. In this instance the Glacier Cash Option may be a good alternative as they receive the benefit of communication as to when the time may be right to move into growth assets including the administrative benefit of having funds on the platform ready to deploy the cash at such a time. This better equips the investor and intermediary to facilitate moving into growth assets. While one may be grappling with the decision to remain in cash or invest in these uncertain markets, the most important factor remains the investor’s risk tolerance, financial objectives and time horizon.