Improving the odds in 2019

The case for alternative investments.

Many investors started 2018 with great optimism. Our country had a new leader at the helm, the JSE was flirting with the 62 000 level, and it seemed that we might finally see the trend of poor performance come to an end.

Unfortunately, our market has been hammered by political and policy uncertainty, a technical recession and a global Emerging Market risk-off appetite. Investors looking to close out 2018 ahead of the festive season now find a JSE at levels reminiscent of mid-2014. If there is the possibility of a repeat performance in 2019 what could investors be doing to improve their odds? For some the answer might be found in introducing alternative investments as a complement to the conventional investments in their existing portfolio.

In developed markets alternative investments are more common place, making up close to a third of an investor’s overall portfolio. But in South Africa, where it is already widely accepted that there is a poor culture of saving, alternative investments seldom feature with any degree of prominence. And whilst Regulation 28 of the Pension Funds Act (which governs the maximum allocation to various asset classes) has gradually increased the threshold to the now 15% allowable allocation in alternative investments very few pension funds have taken significant advantage.

Exploring alternative investments

The absence of indirect exposure (through the likes of a pension fund) means that investors may need to look at making a direct investment. Alternative investments can include tax-managed income unit trusts, structured or capital protected products, unlisted property, private equity and Section 12J investments. These provide investors with a return profile that has a lower correlation to conventional investments such as listed equities and bonds. This means the portfolio could gain some stability (as alternative investments can be less volatile than listed investments) and access to different strategies and asset classes that offer diversification and potential return enhancement.

It must be noted that in order for an investor to enjoy these benefits and potential return enhancement they will have to accept the accompanying levels of investment risk, illiquidity and longer investment horizons that could apply. But it is these features that ultimately assist the investment manager in pursuing the mandated strategy which is to outperform conventional investments.

Some options growing in popularity

In the RisCura-SAVCA South African Private Equity Performance Report for the period ending March 2018 private equity had (net of fees) outperformed the JSE’s All Share Total Return Index over a three-, five- and ten-year period. And the private equity proposition has in recent years been further enhanced through the introduction of Section 12J (of the Income Tax Act). This tax incentive encourages investment in a range of small and medium sized South African private companies, promoting economic growth and job creation, and giving investors access to a well-regulated private equity investment that is 100% tax deductible.

A second option may be inclusion of structured or capital protected products as a way of managing the downside risk on the risky portion of the investor’s portfolio. These offer some form of capital protection at maturity, usually after three to five years, as well as a geared return linked to a predetermined basket of (for example) international equity indices.

Thirdly, investors could look to the discretionary cash portion of their portfolio and the opportunity to maximise after-tax returns. This is generally achieved by investing in tax-managed income unit trusts. These conservative funds produce predominantly dividend returns, aiming to outperform the after-tax yield on money market or enhanced cash funds.

In closing

So for investors feeling that it may be time to explore new investment options and strategies it could be worth having a conversation with your financial advisor to see if alternative investments have a place in your portfolio.