Paul Hutchinson, Sales Manager
Malcolm Charles, co-portfolio manager of the Investec Diversified Income Fund equates a 3-year fixed deposit to an online date; the only difference being that with the fixed deposit, you have to wait 3 years before you know whether you will get lucky!
So, will you get lucky?
Very simply, while you know upfront what your return will be when investing in a 3-year fixed deposit, you do not know what the return would have been had you invested in an alternative income-yielding product, such as the Investec Diversified Income Fund.
The following graph compares R100 invested in a 3-year fixed deposit1 to R100 invested in the Investec Diversified Income Fund over time i.e. we have compared the 3 year fixed deposit rate available on, for example, 1 July 2014 – this then being the return that the investor would receive if he had remained invested in the fixed deposit for the full 3 year period to 30 June 2017, with the performance of the Investec Diversified Income Fund for the 3 years from 1 July 2014 to 30 June 2017.
Figure 1: Value of R100 invested in a 3-year fixed deposit compared to the Investec Diversified Income Fund over rolling three years
|ANNUALISED PERFORMANCE (%)||FUND||BENCHMARK|
Source: Morningstar and Investec Asset Management as at 31.08.17. Returns are calculated on a NAV-to-NAV basis, net of A-class fees (performance start date = 30.09.08, A-class start date = 30.09.09), with gross income reinvested. Highest and lowest 12-month rolling performance since inception is 12.8% and 4.1% respectively. Benchmark: STeFI Composite (ALBI 1-3 pre 01/07/2011)
1Proxied by historic 3-year Negotiable Certificate of Deposit (NCD) rates adjusted by a liquidity premium, as 3-year fixed deposits are not as liquid as 3-year NCDs.
The graph shows that 75% of the time the value you would have realised by investing in the Investec Diversified Income Fund (after fees) equalled or exceeded what you would have received from a 3-year fixed deposit i.e. you would have been better off investing in the Investec Diversified Income Fund three quarters of the time. Importantly, the Investec Diversified Income Fund has also consistently outperformed its benchmark over rolling 3-year periods.
Looks can be deceiving
Online dates don’t always look the same in person as they do in their (PhotoShopped, outdated) pictures. The same can be said for how fixed deposit rates are quoted.
In many cases fixed deposit rates are quoted as ‘interest at maturity’, which is a euphemism for a simple interest rate and excludes the power of compounding. This differs from the standard yield quoting convention of fixed income securities, which are usually quoted as nominal annual compounded semi-annual rates (NACS).
To give you a sense of how different these rates can be, a 5 year fixed deposit which is quoted with an “interest at maturity” of 9.55% has the equivalent NACS yield of 7.96%; a difference of approximately 1.59%. The gross NACS yield of Investec Diversified Income at the time of writing (31 August 2017) was 8.94%*.
The cost of breaking up
Separating from a long-term relationship can be expensive, and the same can be said when trying to break a fixed deposit.
When you invest in a fixed deposit there is a contractual undertaking not to withdraw before the end of the agreed term. If your situation changes and you require your money early it is considered a breach of contract. The bank is then entitled to claim damages and apply a penalty. Where a client requires their money one year after making a three year fixed deposit, the bank will recalculate the interest at the lower one year fixed deposit rate and apply an additional break penalty. This penalty is dependent on prevailing market conditions and the liquidity position of the bank. Unfortunately there is no transparency in the calculation of this penalty and it can be substantial. Indeed it is worth asking the bank before entering into the contract if your capital is considered at risk in the event that the penalty is applied.
By way of contrast flexible fixed income unit trust funds such as the Investec Diversified Income Fund, allow investors immediate access to their money, no strings attached.
Given the uncertain political, economic and investment environment, the decision to lock up money at a fixed rate may prove riskier than investors realise. For example, if fiscal deterioration leads to higher yields, the Investec Diversified Income Fund’s flexible investment strategy will allow the fund to adapt and exploit opportunities, whereas the fixed deposit return will remain static.
Other important considerations
Negative real returns
In the face of ongoing market volatility and weakness, local investors have continued to de-risk their portfolios by selling out of growth assets and investing into the money market. As a result, retail bank deposits now exceed R1 trillion, up from R700 billion in only 24 months. Many would consider this to be a riskless investment, however, it is important to note that the market is pricing in the probability of further repo rate cuts (by as much as 50 basis points). So, whereas the average money market fund returned 7.8% for the one year to 31 August 2017 (source: Morningstar), we believe investors can now expect the average money market fund to return closer to 7.25% one year from now.
In this environment of falling interest rates, the risk to investors invested in the money market is that after tax and inflation they realise a negative real return.
*The net current NACS yield of Investec Diversified Income at the time of writing (31 August 2017) was 7.94%.
A fixed deposit generates interest income, which is taxable at your marginal income tax rate. While the bulk of the return generated from a flexible fixed income fund is interest income and therefore also taxable at your marginal tax rate, a portion of the return is via capital gains and therefore subject to less punitive capital gains tax.
The value of independent financial advice
We believe that for most investors, investing in the money market, including fixed deposits, is not a viable long-term investment, since returns are only likely to match inflation at best. As always, given the importance of making the correct decision, we strongly recommend that investors seek professional investment advice, tailored to their individual circumstances.
portfolio net asset value to bridge insufficient liquidity, and scrip lending. A schedule of charges, fees and advisor fees is available on request from the Manager, Investec Fund Managers SA (RF) (Pty) Ltd which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. CISs are generally medium to long-term investments and the manager gives no guarantee with respect to the capital or the return of the Fund. Performance shown is that of the Fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax and past performance is not necessarily a guide to the future. The value of participatory interests (units) may go down as well as up. Performance figures above are based on lump sum investments, using NAV to NAV figures net of fees with gross income reinvested, in South African rands. The value of participatory interests (units) may go down as well as up. Different classes of units apply to the Fund and the information presented is for the most expensive class. Fund valuations and transaction cut-off time are 16h00 SA time each business day. This portfolio may be closed in order to be managed in accordance with the mandate. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. A higher Total Expense Ratio (TER) does not necessarily imply a poor return, nor does a low TER imply a good return. Where portfolios invest in the participatory interests of foreign collective investment schemes, these may levy additional charges which are included in the relevant TER. The ratio does not include transaction costs. The current TER cannot be regarded as an indication of the future TERs. Fund prices are published each business day in selected media. Additional information on the Fund may be obtained, free of charge, at www.investecassetmanagement.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. Investec Asset Management (Pty) Ltd (Investec) is a member of the Association for Savings and Investment SA (ASISA). The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. All information provided is product related, and is not intended to address the circumstances of any Financial Service Provider’s (FSP) clients. In terms of the Financial Advisory and Intermediary Services Act, FSPs should not provide advice to investors without appropriate risk analysis and after a thorough examination of a particular client’s financial situation. Investec Asset Management (Pty) Limited is an authorised financial services provider.