Diversification in investment portfolios is key
Investing is a long-term game, and 2020 has proved no different in this regard, with economic and geographic sector diversification paying off
As 2020 draws to a close many South Africans are all too ready to see the end of this rollercoaster year. This time last year many of us had vastly different expectations than where 2020 has taken us.
We expected muted economic growth as policymakers and the private sector were set to continue to muddle through the complexity of implementing meaningful structural reform. Globally, lower equity market returns were anticipated. The same was expected from the JSE, although we expected that the local market performance would exceed money market returns.
We expected fiscal pressure due to problematic state-owned entities (SOEs) and an anticipated ratings downgrade to junk. While we expected the rand to depreciate slightly, we anticipated a benign inflation environment and a single 25 basis point rate cut.
For the first two months of the year, these expectations played out. However, the world was turned upside down in March when Covid-19 spread from China to the rest of the world and stringent lockdown regulations took effect globally.
The JSE all share started the year at just above 57,000 points. On March 24 the index dropped to just above 38,000 points — a 33% decline. But April and May saw a strong recovery, with the index rebounding to just above 51,000 points at the end of May. As of December 8 the all share had reached 59,000 points and has delivered a total return of 7.1% so far this year.
Investors who stayed the course despite the major volatility experienced in March would have been happy with the returns achieved this year — particularly against a backdrop of a global pandemic. A common mistake made by investors is to sell out of investments during an adverse market event then enter the market again when stability occurs, which can result in permanent capital losses. Long-term investors need to ride out waves (or tsunamis) of short-term volatility, keeping their long-term goals in mind. Chopping and changing positions frequently is not a successful long-term investment strategy.
Risk needs to be spread globally, giving your capital the best chance to outperform the increased cost of living and to achieve sustainable long-term returns
The price of gold at the beginning of 2020 was just under R21,000/oz. It reached a high of just over R36,000/oz in August and was up 31% year to date as at December 8. The increase in August was a combination of one in the physical commodity as well as rand depreciation. The strengthening of the rand towards the end of the year saw the price per ounce decrease to just above R28,000.
Commodities such as gold are a powerful diversification tool in that they act as a safe haven investment during adverse market events. The world tends to turn to physical commodities when there is market uncertainty. The incorporation of gold into a portfolio can assist in spreading overall risk and shelter investors from equity pullbacks during times of uncertainty.
In a bull market, diversification can be overlooked by investors as prices are increasing. However, when the unexpected happens the impact of weak diversification is magnified. A balanced portfolio means investing in assets that do not necessarily move together. Looking at past data only confirms how crises resulted in gold price increases, confirming the balancing effect a physical commodity such as gold can have on a portfolio.
Gold can also act as an effective hedge against rand depreciation. As gold is valued in dollar terms, a depreciation in the rand is positive for investment return.
Local government bonds received a double whammy this year. An expected downgrade to junk by Moody’s saw the country’s sovereign instruments fall out of global investment-grade bond indices, which resulted in selling pressure leading into March. Global risk-off sentiment following the announcement of hard lockdowns globally resulted in a further spike in bond yields. The SA 10-year government bond yield stood at just more than 9% at the start of 2020 but peaked at 12.38% on March 24. The yield on this instrument, which acts as a proxy for the bond market, has since steadied to 8.85% as of December 8.
The JSE all bond index has delivered 7% in 2020 so far — a decent return for patient investors, despite the challenges faced in this area of the market. Government bonds are bought by investors as they provide a predictable income stream in the form of regular, predetermined payments. In times of market uncertainty, fixed returns well above inflation can offer investors a solid platform to outperform the increase in the cost of living as well as spread their risk.
When held to maturity, investors receive their capital back and thus preserve capital over a fixed period. Like gold, bonds behave differently to equities providing investors with another useful tool in balancing their portfolios. Government bonds are one of the less popular asset classes, due to their complex nature. However, investors can consider these types of fixed-income securities in their portfolio when looking to reduce portfolio risk through different asset class composition.
The Nasdaq composite index fell by about 2,400 points in the four weeks from February 12 to March 11, but has recovered to 12,349 points as of December 8. In February 2020 the index stood at a little over 9,700 points. Year to date, the index is up just over 39%.
The Dow Jones industrial average fell just over 10,000 points to 20,000 points during March but has since recovered to just over 30,000 points. Year to date, it is up 5.89%. The S&P 500 fell just over 1,000 points to 2,600 points during March but has since recovered to just over 3,600 points. Year to date, the index is up 14.1%.
The JSE makes up less than 1% of global market capitalisation. Successfully diversifying a portfolio means investing in different geographies outside SA. The US market allows investors to obtain exposure in technology stocks, something the JSE can only offer through Naspers. Investments in US technology companies found investors obtaining exposure to a new sector that was set to thrive under the lockdown regulations. The global lockdown resulted in increased demand for technology, thus we saw a major increase in the prices of the stocks exposed to the sector.
Diversifying your share portfolio not only relates to different sectors but geographic locations as well. Should the JSE see a reduction in growth, your international performance might balance returns out. By limiting your investments to SA only, all your risk is concentrated in one location. Risk needs to be spread globally, giving your capital the best chance to outperform the increased cost of living and to achieve sustainable long-term returns.
Although 2020 presented many obstacles, it also gave us a new outlook on life. Boardrooms were replaced with Zoom and Microsoft Teams and parents juggled family and working from home. Many of us became more comfortable with using technology for everyday purposes, such as buying groceries, clothing and medication.
One aspect of investing that was magnified during the lockdown was the importance of diversification. Introducing different asset classes and geographies into a portfolio can certainly be put down as one of the major lessons from this year. Perhaps the most important lesson learnt was to “stay the course”. Long-term investing goes hand in hand with being patient and recognising that big short-term movements are exactly as described — short term.
As 2020 approaches its much-anticipated conclusion, the lessons learnt must be taken advantage of and used to make better investment decisions.
• Riemer is investment education head at FNB Wealth and Investments.
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