In the previous educational supplement of this series, Investment Fundamentals I, asset classes as per Regulation 28 were introduced. This article focuses on how to construct an investment portfolio using the asset classes specified in Regulation 28.
A collective investment scheme, often referred to as a unit trust, is a professionally managed investment vehicle which pools together money from a variety of investors and uses this money to invest in different securities such as stocks, bonds and other assets.
Investors in these funds may be retail or institutional in nature. Collective investments are well-suited for retirement funds as they are structured according to certain mandates from which they cannot deviate. In addition, due to the wide variety of securities in which they invest, collective investment funds make portfolio diversification easier. There are many different types of funds to choose from, some of which will be discussed in this article.
Pure equity unit trusts invest primarily in listed equities, both local and foreign depending on their specific investment mandate, which may be determined by market capitalisation, industry; the investment manager’s style or a specific risk-adjusted return objective.
The availability of such a wide selection of equity unit trusts makes them an ideal choice for many investors, as there is likely to be an equity fund to meet any risk/return objective and risk tolerance that an investor may have. By virtue of their higher concentration of risk assets (equities are susceptible to high volatility), pure equity unit trusts are riskier compared with bond and fixed income unit trusts, but equities have proven over the long term to be the only asset class to consistently outperform inflation.
Equity funds are practical investments for most investors because their portfolio diversification reduces risk for investors. A more diversified fund will reduce the overall effect of the movement of any one share on the fund’s portfolio, as well as any movement in any one company’s share price.
A balanced fund is very similar to an equity fund. However, in addition to investing in shares, the fund will also invest in bonds and sometimes even money market instruments. The fund usually keeps its allotment of shares and bonds in fixed proportions.
A balanced fund is so called due to the nature of its asset allocation, which is a balanced portfolio of equity, fixed income, bonds and some cash. These funds are preferred by retirees as well as other investors with a moderate risk appetite who seek the security of a lower risk profile than pure equities, but with the prospect of still beating inflation.
Infrastructure funds provide investors with the opportunity to invest in essential public infrastructure assets such as toll roads, airports and rail facilities, for example. These infrastructure investments generally provide predictable inflation-linked returns for investors because the infrastructure sector has high barriers for entry and are long-term, capital-intensive investments. The returns from infrastructure funds combine capital growth and dividend income in a wide range of proportions.
Property funds are collective investments that invest specifically in commercial property such as offices, factories and warehouses, among others. The fund will do this either by investing directly in the property asset or by purchasing shares in property companies or other property funds. Property funds should not be confused with real estate investment trusts (or REITs), as these are investment vehicles that invest directly in income-producing real estate and are traded on an exchange like stocks are. Instead, property funds can invest indirectly in REITs.
An exchange-traded fund (ETF) is a traded financial instrument representing ownership in an underlying portfolio of securities and has the ownership and liquidity characteristics of unit trusts. ETFs make their returns by tracking the performance of a basket of securities. These securities can be shares, bonds or even commodities. ETFs are growing in popularity because they allow investors to gain exposure to different sectors, asset classes, types of shares, commodities or government bonds. The key differentiator for ETFs is that they can be bought and sold the same way as unit trusts.
A hedge fund is an investment fund that pools capital from accredited investors or institutional investors and invests in a variety of assets, often with complicated portfolio construction and risk management techniques. A hedge fund may use any strategy or may take any position that could result in the portfolio incurring losses greater than its fair value at any point in time, and which strategies or positions include, but are not limited to, leverage and net short positions.
Hedge funds have produced increasingly disappointing returns for investors in the recent past and have accordingly fallen somewhat out of favour.
Investors looking for investment opportunities with an overall positive result, both in terms of financial returns and positive social, economic or environmental impacts, could look at impact funds as a possible investment class. Impact funds are a conduit that impact investors use; they are funds that manage assets that have the intended result of achieving positive outcomes in society in addition to financial returns for investors.
The types of investments that impact funds make could be anything from initiatives that invest in renewable energy projects, promote access to healthcare and education, to investing in projects such as affordable housing and student accommodation, for example.
Active versus passive investing
Lastly, when investing, it is important for investors to decide on an investment strategy that will be suitable for them when choosing their investment approach.
There are two main investment strategies, namely active and passive investment management. These approaches differ in how the fund manager utilises investments held in the portfolio over time. Active portfolio management focuses on outperforming the market compared to a specific benchmark, while passive portfolio management aims to track the investment holdings of a particular index.
Regulation 28; Available: www.treasury.gov.za