There have been significant outflows from South African balanced funds over the past year, with most withdrawals moving to safer assets such as fixed income. In addition, the trend towards global equities has continued. As a result, South African money market funds and cash deposits have climbed to record levels.
It’s easy to see why investors have moved towards less risky assets: the most recent returns. The rationale, it seems, is that it has not paid to take risks in South African investments over the last few years.
With long-term interest rates consistently in the low teens, income funds have outperformed or matched the returns of funds investing in riskier assets such as SA equities and property. Some income funds have delivered returns of around 11% over the past year. Given that you can earn 5-6% above inflation with minimal risk, why would you decide to invest in riskier options?
The problem with this argument is that it is most prevalent at inflection points in the cycle. As interest rates hover near the top of the cycle, income funds perform at their best, often better than riskier, balanced, or equity funds. This is when the temptation to avoid risk is at its highest. However, it is a move in the wrong direction. When interest rates start to decline, economic growth is anticipated, improving returns from equities and property. Soon, returns from riskier funds will far outstrip those of safer funds.
If sentiment about the new SA government improves, we may see this type of upside in riskier investments. This is because interest rates could potentially decline further, driven by the positive outlook. This type of scenario could indicate more than just a cyclical turnaround; it could signify a significant positive shift in the investment landscape.
It is a good reminder that the most recent past is not always a reliable indicator of the future. We can rarely make accurate predictions based on what happened over the past year. The opposite is often true: short-term trends are usually not sustainable, and we should be sceptical of them continuing.
It is part of human nature to base our expectations for the future on our past experiences and patterns. We are not good at imagining a future that differs from that. Yet, those who have imagined a different future, have often changed the world with their dreams.
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Kind regards,
Sunél