Risk and Return Matrix

It is a fact of investing that there is a trade-off between the return on an investment and the risk inherent in an investment. Higher long-term average returns are usually associated with higher short-term volatility of returns. The diagram below depicts this principle.

The chart is not meant to be accurate but gives an indication of STANLIB’s expectations in terms of the return / risk characteristics that face each asset class over time. You can mouse over each asset class dot to get a brief risk-return description, or click on the asset class name to go to our portfolio offering relevant to that asset class.

Africa

The new investment buzzword! Why? Because growth prospects in developing economies, like many of those in Africa, are estimated to surpass mature economies. Increasingly African stock exchanges are attracting inflows from investors wanting to participate in the upside.

However, investment in Africa requires caution. All markets are driven by sentiment, but African markets typically have less liquidity than developed markets. This can cause greater volatility when a change in sentiment occurs.

Foreign equity

Foreign stock markets behave much in the same way as at home – they are driven by economics in the long term and by sentiment in the short term.

In addition to the usual stock market volatility, a local investor with an offshore exposure will be influenced by the currency movements – which add another layer to the volatility.

Equity

Past data shows that, over the long-term, equities have provided the best inflation beating returns. Thus any investor looking for long term real returns should have at least some exposure to the share market.

Equities are more volatile that the other asset classes. Their short term returns depend on investor sentiment, here and abroad. The roller-coaster-ride nature of equities makes them unsuitable if short-term capital protection is required.

Property

In a portfolio context, property refers to office, industrial, retail and (to a limited extent) residential space.

Direct property has income and capital streams similar to those of bonds. Direct property is not liquid and is therefore, generally, unaffected by short term sentiment issues.

For listed property, while the fundamentals are the same as for direct property, the actual listed company’s share price is affected by sentiment and market conditions. Therefore listed property can, at times, behave similarly to the equity market.

Foreign bonds

Sovereign bond problems in Europe notwithstanding, this asset class is expected to behave in a similar manner to local bonds. However, a local investor with an offshore exposure will be influenced by the currency movements – which add another layer of uncertainty.

Bonds

Bonds are expected to beat cash returns over a medium to long term. They are less volatile that equities and can be used to match certain types of liabilities, such as regular pension payments.

Different bonds have different risk return characteristics. Government bonds have the best risk profile and therefore typically offer the lowest yields. The risk associated with any other instrument with the same maturity would be reflected in the difference between its yield and the Government bond yield.

Cash

Cash is the safest asset but also the one that is least likely to consistently beat inflation. It is therefore not a particularly good store of value over the long term. However, some cash is needed in any portfolio to facilitate transactions.