What affects investment returns?

Your clients may have some concerns, particularly in light of the current investment climate. The JSE All Share Index gained 0.3% from the start of the year to end August 2018. Over the same period, the All Bond Index returned 4.5%, SA Cash gained 4.8% and listed property fell by a whopping 20.1%¹.

This tells you that no matter which company your clients invested with or which fund they invested in, low returns are currently being seen across all asset classes. However, in addition to the current economic environment, there are other factors that affect the final return figure on an investment statement.

1. The effect of an investment contribution method on returns

Clients can choose to invest in one of two ways – either through a lump-sum investment or recurring monthly contributions.

Lump-sum investments: An example of a lump-sum investment would be if a client invested a single amount into a unit trust fund. When growth is calculated on this investment, it is calculated based on the single lump-sum amount.

Recurring contributions: If a client invests through recurring contributions, for example, a debit order of R500 a month, they will experience a different return profile. Because contributions are invested at different times, the growth on each contribution will accumulate at different rates. This is due to the fact that markets are unpredictable in the short term.

Additional actions that affect the overall return of both lump–sum and recurring investments include the following:

• Additional contributions: Since the size and the timing of an additional contribution might be different to the initial or monthly investments, the growth on additional contributions will be different in rand terms. The overall return will be affected more by larger contributions that have been invested for longer.
• Partial withdrawals: If a client withdraws from their investment, they will miss out on future returns.
• Switches: Switching between different funds will have an impact on the investment return as different funds grow at different rates.

2. The effect of an investment’s timing

A big factor that comes into play here is timing. When did the client invest in a particular fund or enter the market? A fund factsheet typically shows returns from 1 January to 31 December.  

Many investors incorrectly believe that if a fund factsheet depicts a 12% annualised return, they would have received approximately 1% per month over the year, ignoring compound interest.

Besides fees and commissions, which detract from investment returns, it is important to point out that the way a unit trust fund accumulates returns over time is not necessarily linear. Investment returns are chunky and can be both positive and negative over any investment period, in this case, a year.

Source: Morningstar as at 31 March 2018

Take the above, an example of a well-known asset manager’s equity fund. The first chart shows the average annualised return of the fund over a year, while the bar graph shows the way in which the fund generated its return over the same period, month by month.

It is easy to see that the returns earned over the period was 5.63%, and that is shown on their fund factsheet as represented by the first graph. However, if you look at the distribution of returns over time, these were not earned equally.

For example, the return for June 2017 was a negative 3.35% and a month later in July it was 6.1%. But if you average it out over the full period from April 2017 to March 2018, you get an average annualised return of 5.63%.

3. The effect of fees on an investment

A difference of just 1% in fees can have a big impact on clients’ savings. They need to read their statement carefully to ensure they understand the charges and speak to you, their financial adviser, if they have any questions.

In 2016, the Association for Savings and Investment South Africa (ASISA) introduced Effective Annual Costs (EAC), which was designed to allow investors to easily compare fees on two competitive products. The four cost disclosures that must be shown are:

Investment management charges: These include the charges of any wrap product, such as a fund of funds, and those of the underlying funds, as well as things such as stock broker charges and VAT.

Advice charges: If Discovery pays commissions or fees to you on the client’s behalf, these fees must all be disclosed. This includes all initial and annual fees on both lump-sum and recurring-contribution products.

Administration charges: All charges relating to the administration of the product must be disclosed.

Other charges: This includes all remaining charges, such as termination charges, loyalty bonuses, guarantees, smoothing or risk benefits, and charges for risk benefits such as a premium-waiver benefit. These charges must all be explained in notes published directly under the EAC table of costs.

Each of the four components must be calculated and disclosed separately and then totalled to provide one EAC figure for the financial product, expressed as a percentage of the investment.

These factors affect an investment’s internal rate of return

An investment’s internal rate of return is the annualised rate of return the investment portfolio has produced. This rate includes all costs and tax already paid.

When a client looks at their investment statement, the internal rate of return figure is arrived at once all the above factors have been taken into account, as well as any transactions that might affect this rate.

The solution is to stay focused and stick with an investment strategy

History shows us that over the long term, an investment is likely to show an upward trajectory, ironing out the dips that may have occurred along the way.

The key is that clients have to remain impartial to short-term movements (under one to two years) and stay focused on their long-term investment objectives (five to 40 years). They should avoid emotional investment decisions as this ends up destroying the value of an investment in the long term.  

Why Discovery Invest should be your partner of choice

Despite the current difficult economic environment:

• The Discovery Balanced Fund had a return of 9.07% for the year to end August 2018 against a benchmark return of 3.80%²
• The Discovery Diversified Income Fund had a return of 8.47% for the year to end August 2018 against a benchmark return of 7.29%²
• Our flagship fund, the Discovery Balanced Fund, was the 7th biggest flow taker in the industry, with net flows of R989 million for the second quarter of 2018, making it the 12th biggest retail fund out of more than 1 000 funds in the country (excluding money market funds), as per ASISA (www.asisa.co.za)³
• The Plexcrown Survey for quarter two 2018 shows Discovery Invest retaining a place among the top five asset managers in the country⁴.