In a nutshell: Investing differs from saving. You save money in a bank account or stokvel, while you typically invest money in asset classes. Asset classes include cash, property, equity, debt, and alternative assets such as private equity or infrastructure.
Saving is setting money aside for things you need to pay for in the near future, like saving for a bicycle or PlayStation. Savings are typically accessible and unlikely to earn interest that beats inflation and tax.
Investing should be done for longer periods that enable you to beat inflation and tax and to harness the power of compounding (earning interest on interest). For example, buying a car or a flat.
When you receive your first pay-cheque, it might seem impossible to ever have enough money left for investments. But there is never a better time to invest than the present!
There are certain places where money can grow. No, it’s not on trees! However, your money has the potential to grow if you “plant” it in the right asset classes.
In the world of finance, an asset is anything that has economic value – something that you can sell for money, like a car, bicycle or smartphone. Savings in the bank are also an asset.
Asset classes are groups of assets that have similar characteristics. Assets in the same class will pose similar risks and offer similar returns.
There are five main asset classes, namely cash, equity, debt, property, and commodities, and you also get alternative assets.
Risk profile: Low
Cash refers to any positive balance or deposit in a South African bank account. This includes savings, fixed deposit or money-market accounts, as well as acquiring other currencies like US dollars or Euros.
Cash is viewed as a low-risk investment. You’re not going to get rich quickly as cash grows slowly and usually at a steady or fixed interest rate. But there’s also very little chance of losing any money.
Ata’s retirement fund invests R500 000 in a money-market account at an interest rate of 7% for 12 months. At the end of the year, the money will be worth R535 000. The fund’s money only grew by R35 000, but it didn’t lose any money.
DEBT INSTRUMENTS or BONDS
Risk profile: Low-Medium
It sounds counterintuitive, but you can invest in debt. Individuals, businesses and governments can borrow money that must be repaid over time, with interest. An investor (that’s you) can provide a lump sum in exchange for payments (with interest) at regular intervals, i.e. monthly or yearly. That sounds risky; however, these debt instruments (also called bonds) are guaranteed or backed by an entity such as a government, a bank or a company.
Risk profile: High
Equities refer to shares. Companies can issue shares to raise money from investors. If you buy shares in a company, you actually “own” a part of that company. The company uses this money to grow and develop its business. Shares are bought and sold on a stock exchange like the Johannesburg Stock Exchange (JSE).
Vodacom’s shares are worth R10 each. Nomnikelo, an asset manager, buys R500 000 worth, or 50 000 shares, for your retirement fund. The company performs well, and the share price rises. After a few months the share price is R12, and your fund’s shares are now worth R600 000, thus your money has grown by R100 000. Compare that with the cash investment! However, the share price could have dropped to R7, and then your fund could have lost R150 000!
Risk profile: High
This asset class includes physical properties that you buy in order to lease to tenants, such as houses, office buildings, malls, industrial parks, etc. When you lease your property, you earn rent from the tenants every month. You can also invest in property without buying a physical brick building, by investing in real-estate investment trusts (REITs). You then own a small percentage of residential, commercial or industrial property.
Risk profile: High
Commodities are raw materials that are bought and sold on global markets where economic forces (supply and demand) and other global issues (e.g. wars, droughts, natural disasters) determine the price. Commodities can include agricultural products like maize, coffee, cattle, and fuels like oil and gas, and metals like platinum, gold and steel.
Gold is a metal commodity. Say you invest R10 000 in gold at R1 000 per gram. After a few months, the South African economy goes into a recession. When this happens, many people tend to put their money in gold as it is seen as a safe investment. The gold price increases to R1 100 and your investment’s value rises by 10% to R11 000.
As you can see, debt instruments and cash grow at a steady predictable rate, but the returns are relatively low. Equities, property and commodities are less predictable but can yield much higher returns. Therefore, it is wise to spread your money over a range of asset classes. Instead of investing R50 000 in one asset class, invest a portion in each asset class. In financial terms this process is known as diversification.
Risk profile: High
Financial assets that do not fall under the traditional asset classes are called alternative assets. These include private equity, hedge funds and infrastructure.
Why should I invest in an alternative asset?
It’s all about risk and returns. Alternative assets:
- Offer investors (like you) the opportunity to generate optimal risk-adjusted returns.
- Allow for the use of various strategies. In traditional asset classes, you can only buy and sell, so they only benefit when the economy improves. A skilled alternative asset manager can use different strategies to create returns even in poor market conditions.
- Allow investors to diversify their investments. Instead of putting all your money in one pot, rather spread it across various companies, regions, funds and even managers. If one of these factors to which you are exposed in a well-diversified portfolio performs poorly, the performance of the others should reduce the overall impact.
1 Private equity funds
Risk profile: High
Private equity is a broad, catch-all category for any equities (shares in companies) that are not publicly listed. Companies like MTN Group Ltd and Capitec are public companies whose shares are traded on the stock exchange – anybody can buy or sell shares in these companies.
A private company’s shares are held internally by a small number of shareholders. These shareholders can be individuals, trusts and/or companies.
A private equity fund typically comprises silent investors (called Limited Partners – or LPs) who pool funds alongside an active investment manager (called the General Partner – or GP) for a fixed period (e.g. ten years). A retirement fund can be a limited partner. The fund then invests in various private companies, works to increase the value of these companies, and sells these companies within a fixed period, whereafter the fund is closed, and profits returned to investors.
Private equity generally invests in established businesses with growth potential that are looking to raise capital to expand or improve their operations. We refer to investing in start-ups or early-growth companies as venture capital investing.
2 Hedge funds
Risk profile: High
Hedge funds aim to generate high returns for their investors regardless of market conditions. So, even if the stock market is in a downturn, a hedge fund can generate returns. The hedge fund does this by using an array of complex investment strategies that allow it to take more risks than a traditional investor would take. In return, it can expect a higher yield.
Traditional funds typically generate returns by taking what are called long positions. They buy shares, hold on to them and sell them at an opportune time.
Hedge funds use the above traditional strategy as well as a range of non-traditional ones, including long and short equity strategies, market-neutral strategies, and leverage to generate returns.
3 Infrastructure Funds
Risk profile: Medium-High
You are surrounded by infrastructure: the roads you drive on, the hospital your aunty works at and the pipe system that supplies water to your home all fall under infrastructure. Even the cellphone towers and WiFi network that enable you to read this article are part of infrastructure assets. If managed properly, infrastructure is what makes a country work.
Given infrastructure’s long-term nature, investing in these assets can be appealing to retirement funds, particularly in times of rising interest rates and inflation. But the merit of infrastructure investment also extends beyond financial gain; not only does it provide an opportunity to invest in something that has a different risk-return profile to more traditional asset classes, but it also allows investing in and stimulating the country’s socioeconomic growth and development, which in turn can reduce poverty.
How does one invest in infrastructure? Is it as simple as buying shares in a construction company, like Amandla Construction?
Not quite, the construction, operation and maintenance of infrastructure is a long-term process that involves many role players. Infrastructure funds can invest in any of these aspects, for example buying shares in a listed construction company that builds low-income housing. Or the fund can invest in the debt of healthcare service providers such as Netcare or Mediclinic.
The term risk-adjusted returns refers to how the potential profit of an investment compares to the risks taken to achieve that return. An optimal risk-adjusted return is when an investor strikes a good balance between risk and return. This results in either beating the returns of traditional asset classes, or reducing the risk associated with them.
This article is funded by
In partnership with