Managing clients’ short-term anxiety for long-term growth

Seugnet de Villiers, Investment Analyst at Nedgroup Investments, reinforces the need to adhere to the basics of investing when helping clients to stick to their long-term investment plans in times of market turmoil.

It’s been a difficult few years for South African investors. The domestic economy has been struggling, we’ve had low GDP growth, government debt is at unsustainable levels and unemployment remains high. As a result, domestic equities have not delivered good growth, which was compounded by the Coronavirus. On 19 March, the cumulative growth of the All Share Index over the last six years had delivered 0% nominal growth. Domestic multi-asset and equity funds over the last 3 and 5 years have not been able to keep up with inflation, let alone outperform their inflation plus targets with many clients partially or fully invested in these types of portfolios. Multi-asset income funds on the other hand, which are limited to 10% equity and mainly hold short-term bonds and cash instruments have performed relatively well, delivering 7% p.a., i.e. cash plus 1%-2%.

Managing investors emotions during market volatility

Clients are naturally feeling that the last place they want to be is equities and that cash offers them a safe haven and better performance prospects in the short term. Now is the time for advisors to step in and manage their clients’ emotions as switching at the current low point of the market is not advisable. Inflows into South African MA Income funds over the last 3 years have been R99 billion compared to R188 billion over the last 15 years. Meanwhile, multi-asset high equity funds have experienced a net outflow of R28 billion, confirming the emotional switch out of growth assets. While income funds offer consistent returns in the short term, they offer low growth prospects in the long term. It’s important to help clients not to get overwhelmed by the complexity of investment decisions by helping them to ignore the noise and focus on making investment decisions based on long-term fundamentals to help them achieve their long-term investment goals.

History shows that markets always recover

The domestic equity market, over the last 100 years, has been through several bear markets with high double digit drops. The drivers of these crises may have been different, but the common thread is that the market always recovers and reaches new highs. The dangerous part of a recovery is how fast and unexpected it always is and usually when it doesn’t make sense. The period up to 24 March was one of the worst months for domestic unit trust funds ever. Without any fundamental change to the outlook for Corona, April was one of the best months ever.

The opportunity cost of switching

Clients who switch too soon stand to lock in significant losses. Example: A client has R100 000 invested in the equity market on 24 February. On 24 March as markets are falling, the clients decides to switch his investment, now worth R75 000, out of equities into cash. Shortly thereafter markets begin to turn. If he had stuck to his initial long-term plan, on 24 April he would have had R90 000, a 10% decline, but preferable to the 25% knock he took by exiting in March. Short-term, emotional decisions like this can be costly in the long term. It’s important to remember that while cash offers steady performance in the short term and is currently attractive, money markets, relative to inflation, do not offer the growth needed for a long-term investment horizon. Over the last 20 years, multi-asset high equity funds have delivered 5.3% per annum in excess of domestic inflation, outperforming money market funds by 2%, not forgetting the compound interest effect over the period. In Rand values, this means that an investment in the multi-asset high equity space has grown to more than double that of an investment in money market over the same 23-year period.

Time in and not timing the market

Historical performance has shown that by staying invested for up to 10 years, the likelihood of equity funds outperforming money market funds is 100%. Your conversation will need to be around the importance of staying invested in high growth assets for the long term, the volatility that clients will need to cope with in the short-term and how long-term growth will not be achieved with income funds. The trade-off is between time, risk and return. The more return you want to achieve, the more risk you need to take and the longer you need to remain invested.

The availability bias

This refers to the shortcut our minds take to judge the likelihood of something happening based only on recent or memorable events and is currently quite present in clients’ investment decision making. However, it’s important to reinforce that short-term volatility and a market crisis don’t change the long-term fundamentals of an asset class, confirming that equities are still a good investment option. In fact, March 2020 was the first month end in the last 20 years where the All Share Index had a 7-year performance below cash.

What client need to do now

It’s important in times of crisis to stick to the basic principles of investing.
• Your investment time frame is still the key driver of the levels of risk you can afford.
• Your tolerance for risk drives the asset allocation to suit your objectives and needs.
• Asset allocation is an important driver of expected return.
• Diversification enables you to reduce risk without compromising return.
• Emotions erode value, so avoid knee-jerk reactions to short-term discomfort.
• Reasonable returns compounded over long periods can produce great investment results.

To listen to this conversation, go to Nedgroup Investments Insights on Apple Podcast, Google Podcast and Spotify.