Issue: June/August 09
Edutorials
Liberty Life

Guide to asset classes

Prepared by Liberty Group Advisory Services

Helping you make an informed decision
You’ve heard that it’s a good idea to ‘diversify into different asset classes’ but what are these asset classes and how do these work?

When choosing the ‘mix’ of assets in your portfolio, you need to understand:

  • The volatility of the asset: how risky is it?
  • The liquidity of the asset: how quickly can you access your money? Are there penalties or fees for ‘cashing in’ early?
  • The returns of the asset: how will your investment grow and what kind of returns can you expect?
  • The advantage and disadvantages of the asset (some of these are listed in this document).

To help you make an informed decision about which assets to include in your portfolio and how to balance your portfolio with different assets, we have prepared this guide to different asset classes.

The table below gives an overview of each asset class: cash, bonds, property and equities. More information on each asset can be found below.

Cash Bonds Property Equities
Interest-bearing and instruments discount instruments Debt instruments Physical property and listed property investment period Large cap and small cap shares
Suggested minimum
1 day 1 – 3 years 3 – 5 years 3 – 5 years

Speak to your financial adviser
Speak to your financial adviser before you invest in or buy a financial product. Your financial adviser will help you draw up a financial plan and guide you in choosing the products and portfolios that are right for you.

Find out more online
For information on Liberty Life products: www.liberty.co.za/Products.
For information on STANLIB products: www.stanlib.com/investment for individuals.

Cash
How it works Access to money Return
INTEREST-BEARING INSTRUMENTS
MONEY MARKET FUND    
Money is invested in money market instruments. Depends on the instrument. Investors have access to higher interest rates. Usually have a higher return.
     
CALL DEPOSIT    
Money is deposited at a bank and ‘called’ for when needed. Interest rate fluctuations. Interest rate is usually not high although could be higher on larger amounts.
     
NOTICE DEPOSIT    
Money is deposited at a bank and notice must be given before withdrawing. Notice must be given to the bank before withdrawing e.g. 32 days to 1 year. Penalties apply if money is withdrawn early. Interest rate fluctuates. Interest rate is usually higher than on call accounts as giving notice allows banks to plan their cash flows.
     
FIXED DEPOSIT    
Money is deposited at a bank for a pre-determined period. Notice must be given before withdrawing. Interest rate is fixed.
     
     
NEGOTIABLE CERTIFICATE OF DEPOSIT (NCD)  
A certificate is bought from the bank and can be traded (sold) to someone else. The certificate is ‘redeemed’ from the bank. The person who holds the certificate will receive interest from the bank.
     
DISCOUNT INSTRUMENTS    
TREASURY BILL    
A short-term loan certificate issued by the South African Reserve Bank (SARB) on behalf of the government. A nominal value is paid to the investor at redemption. A nominal amount less a discount.
     
     
PROMISSORY NOTE    
A loan certificate issued by a large company. The repayment of the nominal amount is not guaranteed by a bank. Because the only guarantee is the soundness of the company, should have a higher return.
     
BONDS    
How it works Access to money Return
Bonds are used to raise long-term finance for the government, semi-government organisation or corporate. They are traded on Bond Exchange of South Africa (BESA). The bond amount and interest are ‘set’ at a certain date which is when the bond reaches maturity and can be redeemed. The bond holder receives the ‘set’ amount and interest when the bond matures. Bonds can be traded before maturity date but only redeemed on the maturity date. When interest rates change, the value of existing bonds also changes. Bond market volatility exists because changes in bond prices are inverse to changes in interest rates.

Bonds: some terminology

  • The coupon is the annual interest return on a bond instrument.
  • A zero-coupon bond is bought at a discount so the coupon value is ‘included’ in the price.
  • Gilts are bonds sold by government.
  • Semi-gilts are bonds issued by parastatals e.g. Transnet or Eskom.
Property      
How it works Access to money Return
PHYSICAL PROPERTY    
The property is registered in the investor’s name. Rental income: capital appreciation on revaluation of the property and eventual sale. Rental income received and increase in the value of the property.
     
LISTED PROPERTY    
The rights to the property are held in an investment product such as property loan stocks and property unit trusts. Rental income in the form of interest semi-annually (like a dividend); capital appreciation is purely stock-market driven. Works the same as an equity instrument. Property, JSE. Rental income received and increase in the value of the property.
     
Equities      
How it works Access to money Return
Companies that are listed` on the JSE Securities Exchange can raise money by issuing shares which give investors part-ownership in these companies.

Shares can be bought directly or indirectly through investment vehicles such as unit trusts, life products and derivatives.
Would depend on the investment product If shares are owned directly, income is earned from dividends and the increase in the share price. Although equities are the most volatile asset class, they have offered the best real returns over the past 5, 10, 20 and 48 year periods. Listed property over more recent periods has marginally outperformed equities.

Equities: some terminology

Classification of shares<
Shares can be bought in different sectors. The JSE defines these sectors as:

  • Resources
  • Basic industrials
  • Financials
  • Non-cyclical consumer goods
  • Cyclical consumer goods
  • Personal care and household products
  • Cyclical services
  • Non-cyclical services
  • General industrials
  • Information technology

Share indices
A sample of shares from each sector is taken and combined to form an index. The performance of a share can be measured against its index.

The indices on the JSE are:
Alsi 40 Top 40 shares
Fini Financials shares
Resi Resources shares
Indi Industrials shares
Findi Financial and industrials shares

Large caps and small caps

  • Large caps are shares of the companies in the JSE top 40. These are usually large, blue chip companies which are well established and financially sound.
  • Small caps are shares in the smallest 265 companies on the JSE and are more volatile than the large caps.

How to minimise equity risk

  • Stick to a long-term plan (stay invested!)
  • Invest regularly
  • Invest in different sized companies and different sectors
  • Invest offshore as well as domestically.

Advantages and disadvantages of different asset classes

    Advantages   Disadvantages
Cash Most liquid and risk-free investment. No hedge against inflation
  Predictable income stream. Lower risk but also generally a lower return.
  ‘Short-term parking place’ for excess funds while deciding where to invest for the longer term.    
  Often seen as a safe haven during economic downturns.    
  Return may outperform equities or bonds over short periods.    
Bonds Investing in bonds allows for diversification of the portfolio. No hedge against inflation (unless the bond is linked to inflation).
  Predictable income stream. Lower risk but also generally a lower return on equities.
  Less risk and volatility than equities.    
  Often seen as a safe haven during economic downturns. Prices can be volatile.
Physical property Less volatility in capital as property is revalued every year. Not affected by market sentiment. Longer-term commitment.
      Invested for the long term and can’t change exposure to different tenants.
  Smoother return.    
  More conservative investment.    
Listed property Allows for diversification of the portfolio. Prices can be volatile and are affected by:
  Consistent cash flows. Negative global equity markets.
  Inflation hedge over the long term. Slump in global growth and impact on commodity cycle.
  Linked to the equity market through    
    capital growth. Sudden currency change and impact
  Linked to the bond market through income yields. on inflation and interest rates, especially bond yields.
Equities Offer the best returns over the medium to long term. Are volatile and require a medium- to long-term view.