Q&A with Anthony Palmer CA (SA) – Equities versus Fixed Income

In these uncertain times, many people are anxious about the markets and wrestle with deciding what their best investment options may be, especially when it comes to a choice between equities and income funds. Anthony Palmer, Director: Corporate and Client Solutions at Carrick Wealth, shares with us his views on the issue.

It should, however, be stressed that these are his personal views and should not be construed as professional advice. As each person’s circumstances vary, one should always consult with a professional financial planner.

Anthony, what do you tell investors that are anxious about the markets and tired of seeing their SA equity portfolio going backwards?

As a wealth manager I am frequently asked why people would choose to invest in the South African stock market instead of keeping their money in a bank and earning a steady interest rate. These client concerns are well founded, especially considering the poor domestic equity market performance and other idiosyncratic risks we have recently seen such as fraud and poor corporate earnings.

Everyone’s circumstances are different but if a client is concerned about capital preservation, willing to forego some longer-term upside and looking for a predictable income then, in my opinion, their investment portfolio should hold a sizeable allocation to a flexible income fund. For companies looking for inflation-beating returns on excess cash reserves, a flexible income fund is also a great solution.

What return can I expect?

I have my favourite income fund and for the purposes of this article I am going to solely focus on it. My clients are often surprised to see a low-risk, daily-traded and award-winning fund that is yielding more than 10% per annum. Using an inflation rate of 4.5%, that means you will receive a real return of 5.5% per annum. I have been using this fund for a while now and was very excited to see it win 2 awards at the end of January - Best South African Interest-Bearing Fund and the Best South African Multi-Asset Income Fund.

  • Since inception and net of fees, the fund has returned an annualised 10.1%
  • To December 2018, over three years and net of fees, the fund delivered a cumulative 42.1%
  • In 2018 the fund returned 9.98%, net of fees

Is it safe?

The Carrick Investment Committee regularly review their approved panel of asset managers and have done an extensive due diligence on the fund. I am extremely comfortable with the fund manager whose team employs a highly rigorous and disciplined investment process in managing risk and return; interest rate and credit risk are exceptionally well managed; there is a very pragmatic asset allocation; and the manager is always mindful of associated risks.

I would categorise this as a low-risk investment and suitable for investments with a 12-month and greater time horizon. For more immediate time horizons, I would use a money market fund although a flexible income fund does have a significant money market allocation.

The fund in question is currently conservatively positioned with approximately 60% in a range of fixed rate bonds, 20% in floating rate bonds and 20% in money market instruments. Within the bonds, more than 80% have AA credit ratings or better.

As mentioned, an income fund should be a key building block, but I still believe that all portfolios should be further diversified by currency, geography and asset class.

What makes this particular income fund different and how do they get such a good, and consistent, return?

I believe there are a number of factors at play. The fund is truly actively managed and has the flexibility to seek out and act on market opportunities as well as to identify and take advantage of miss-priced opportunities in the market. The fund is also small relative to some of the dominant income funds. This means that the smaller and very appealing opportunities have more of an effect on the overall returns.

So, what is a flexible income fund and who can hold it?

A flexible income fund is similar to a bond fund but has a wider mandate allowing additional investments into other asset classes both locally and internationally. The majority of the investments, however, are held in RSA government bonds, cash and South African corporate debt. The fund can be held by individuals, trusts and companies.

What are the risks and downsides?

As with any fixed income investment you will not participate in stock market upside. So, if the stock market rallies from this point you will miss out on growth. With the recent stock market sell-off I am seeing some interesting opportunities in the equity space but predominantly offshore.

Another downside is that all returns are taxable as income. For high marginal rate tax payers and trusts I normally suggest investing via an endowment which reduces the tax rate to 30%.

Thanks for that Anthony. Before we go, what else are you seeing in the market now?

We are certainly in interesting times and the world is changing rapidly. I am seeing South Africans continue to externalise their rands and look for efficient holding structures and investments. Certain clients are looking to shelter some tax by using Section 12 J venture capital companies. For longer-term investors I am seeing a lot of interest in hard currency multi asset investments with satellite holdings focusing on themes such as robotics and automation, healthcare innovation, auto innovation, digitalisation and renewable energy. This is an interesting space and can provide fantastic returns provided you have the stomach for some volatility.

For more information, contact wealthmanagement@carrick-wealth.com