Income funds: a better alternative to the money market
Since the onset of the Covid-19 pandemic in March 2020 and more recently the war between Russia and Ukraine, markets have been highly volatile, causing emotional and risk-averse investors to seek investment alternatives. safer/less risky investment.
As a result, many investors liquidated stock markets and shifted their capital to money market investments. However, the real returns offered by money market investments simply cannot beat inflation at current levels of 5.70%, when the interest rate in South Africa is only 4.25%. .
Income funds are an alternative investment option to money markets. Their objective is to provide a return in excess of money market returns and to earn a reasonable level of income with relative stability of capital and low risk.
These funds benefit from a flexible mandate, fund managers will look for opportunities to invest in money market instruments, different types of bonds such as inflation-linked, floating rate, fixed interest, preferred shares and real estate.
What are the risks ?
Interest rate risk – The risk to which a portfolio or an institution is exposed due to the uncertainty of future interest rates. Due to the interest rate sensitivity of bond prices, if rates rise, the present value of a bond will fall. Interest rate risk therefore refers to the effect of changes in the prevailing market rate on the yield of a bond and includes price risk and investment risk.
Inflation risks – The risk is that when inflation increases, it reduces the purchasing power of your income.
Credit risk – The risk that the creditworthiness of a bond issuer will deteriorate, increasing the required return on that bond and reducing its value. Credit risk includes default risk, credit spread and downgrade risk.
Liquidity risk – Bond risk is due to the difficulty of selling securities quickly at an attractive price. This only applies to the investor looking to sell their bonds before their maturity date. Investors who hold the bond until maturity will receive the principle of the bond plus interest on their face value.
When advisors include options such as income funds in portfolios, where applicable, a popular fund used is the MI-Plan IP Enhanced Income fund, which has successfully outperformed the JSE and provided returns above those of equities. over the past five years, and with much less volatility.
The MI-Plan IP Enhanced Income fund is a typical income fund used by investors looking for options in fixed income funds. The fund currently comprises government bonds (42.59%), corporate bonds (55.32%), securitized bonds (1.43%) and cash and cash equivalents (0.66%) .
The fund’s outperformance against the JSE and the South African interest-bearing money market over the past five years is graphically illustrated below:
In March 2020, South Africa experienced the strongest local bond market correction in the last five years. Despite this slowdown, investors were still able to benefit from a positive return.
Income funds should surely be considered part of an investment portfolio given the excellent risk-adjusted returns and lower volatility compared to other asset classes, especially when markets are so volatile. The percentage of asset allocation to these funds will depend on the investor’s specific risk profile, income requirements and time horizon.