An Introduction to Investment

A Simple Guide to Investment (an insert in Consider This) is published on behalf of Prudential Portfolio Managers by TouchlineCustom Publishing, a division of Touchline Media, PO Box 16368, Vlaeberg 8018. Tel 021-408-3800 Fax 021-408-3811Editor Deborah Herd Deputy editor Jane Surtees Senior designer Hilary Knight Publisher Andrew SneddonPrudential consultants: Head of marketing Debra Roussouw Copy editor Shannon Edwards Contributors David Knee, Steve PowellPhotographs Corbis Images, Getty Images, iStockphoto

ost of us work to live, rather than live to work. Mostof us dream of the day when we don’t have to work

and can enjoy life to the full.

To do this we need to consider investing for our futureand making our money work for us, even when we are nolonger working.

When it comes to investing, the sheer volume of facts andinformation available can be incredibly time consuming towade through and for many individuals the jargon used is justtoo confusing.

Yet we need a good understanding of the financial optionsavailable to us – and the risks and rewards associated with each –to be able to make good investment decisions.

Prudential Portfolio Managers has built its reputation of prudentvalue investing upon a comprehensive understanding of marketsand the many factors that influence the price of an asset.

So whether you are an existing investor or looking to invest forthe first time, we thought the following simple questions andanswers would help you by demystifying financial markets.

introduction

M

When you invest your money it will earn money for you… but, like everythingelse in life, there is risk involved.

Because of this, many people choose the “safer” option, such asdepositing their money with a bank or investing it in a Money Market Fund.

It is the uncertainty about the risk of possible capital loss that may driveyou to take the safest route but consider the following:

• Shares have beaten cash almost two thirds of the time over all 10, 15 and20-year periods since 1962;• South African equities have never delivered a negative return over anyfive-year period.

The return earned on cash is directly related to the official level of interestrates set by The Reserve Bank. Therefore, when interest rates increase, cashreturns increase, and when interest rates decline, the return on your cashdeclines. Interest rates in South Africa have been on a downward trendfor the last decade, helped by generally lower levels of inflation. This hasundermined returns from cash. Bonds, property and shares have, in contrast,benefitted substantially from this.

So, if all your cash is securely deposited in your bank, it is definitelynot working as hard or growing as fast as it potentially could if investedelsewhere and with a longer term focus.

Is my money currently working as hardfor me, as I do to earn it?

1

Balance is an important part of life and the same is true with investments andthe following need consideration.

• Do you want low risk and low returns versus higher risk and higherreturns… or a combination of both?• Do you want regular income versus capital growth… or a combinationof both? Bear in mind that there may be tax implications of this choicedepending on your circumstances and prevailing legislation at the time ofinvesting. Your accountant may be able to clarify this matter with you.

It is important to familiarise yourself with the types of investments availableand the risk and rewards associated with each option. All things considered,find the most financially rewarding approach that balances your incomeneeds with longer term capital growth.

OK, so how do I get my money workingharder but also smarter?

Risk at a glance

2

Historically, gives you better returns thancash, but are lower risk than equities

Your capital’s secure, but there’s littlepotential for it to grow

Higher risk to capital than amainstream equity fund, but givesyou great potential for growth

Good growth potential, but youmay not get back your originalcapital investment

Higher risk of default thaninvestment-grade corporate bonds,but still safer than equities issuedby the same company

Slightly riskier than government bonds,but still safer than the stockmarket

Cashin abank

Governmentbonds

Funds investing incorporate bonds

Funds investing in highyield corporate bonds

Funds investing in larger,established companies (equities)

Funds investing in lesswell-established companies (equities)

Low

HighsOurce: PruDentIAl

3 What are bonds and what are equities?

A bond is a loan made by you to a government or company when it needs toraise additional capital to finance new business opportunities. Bonds issuedby governments are called government bonds, sovereign bonds or gilts, whilebonds issued by companies are called corporate or credit bonds.

Equities are shares in a company. When you buy equities, you are actuallybuying a share of the company itself. As a part owner, you share in thesuccess or failure of that company and these fortunes are reflected in theshare price on the stockmarket. So when the company does well and profitsrise, the value of your shares go up, and when it doesn’t, the value of yourshares will fall.

Bonds are generally affected by changes in interest rates rather thanfluctuations in the stockmarket. Their prices move less sharply than equitiesand they are thus often regarded as a safe-haven from stockmarket

turbulence. Neither bonds nor equities are risk free so toreduce the risk of your portfolio you should consider

balancing your investment portfolio with both bondsand equities in order to diversify these risks.

Bank deposit Bond fund Shares

Income Lower level ofincome

Higher level ofincome

Lower level ofincome which canfluctuate

Capital No growth incapital but thereturn of capital ismostly assured

Some opportunityfor growth butcapital is notsecure

Higher possibilityfor growth butcapital fluctuatesand is not secure

If you are looking to grow your capital at a higher rate and are accepting ofrelatively higher risks, your portfolio would lean towards equities. If, however,you are not willing to take risks with your income, you may want to increasethe percentage of bonds you hold.

A rule of thumb to consider when calculating the percentage of bonds youshould have in your portfolio is your age. If you are 58, for example, 58% ofyour portfolio should consist of bonds. Alternatively, if you are 63, then 63%of your portfolio should be in bonds, although individual circumstances varyand this is only a rough starting point.

In the long run, equities should outperform bonds but bonds typicallyprovide higher levels of income than both equities or cash in the bank.

What is the difference between puttingmy money in a bank, a bond fundor investing in shares?

4Asset classes

Return

Time

+ Secure+ Accessible+ Regular yield

– No inflation protection

Cash

+ Growth (capital & income)+ Inflation protection

– Volatility (capital loss)

Equity+ Fairly secure+ Higher yield

– Subject to interest rate cycle

Bonds

+ Positive factors– Negative factors

Investing should be continuous and consistent because by investing oftenyou smooth out the highs and lows of the market. When shares go downyour regular contribution buys more than usual and when the share pricesubsequently rises, the value of your investment benefits accordingly.

5 When is the best time for me to investand for how long should I invest?

Investing requires a long-term view and virtuous patience whichin essence means an investment needs at least five years for itsearning potential to be realised.

We all want more money but that is just part of the reason forinvesting. The other part is how you want it delivered.

This can be done in two ways: a ‘regular income’ (whichgives you regular payments) or ‘growth’ (a big lump sumreceived at the end of your investment period).

Smart individuals choose to invest with a long-termview but before you invest you must consider whatyou want from your money to determine the time youneed to invest for.

Prudential explains: The financial crisis of the past three yearshighlighted the fact that, over short periods of time, share markets canmove up and down a great deal. In 2008, the price of the JohannesburgAll Share Index, a basket of the shares of the largest 160 South Africancompanies, fell 25%. In 2009, it proceeded to rise by some 28%. Afterallowing for the modest income from dividends, for someone who puta lump sum to work on December 31 2007, two years later the valueof their investment would have got back to where it started. Hardly astunning result. In contrast, if someone had put R1 000 in the marketper month over that same period (a total of R24 000 over the twoyears), their investment would have been worth almost R28 000 onDecember 31 2009, demonstrating that, by investing regularly, much ofthe effect of market volatility is removed.

The degree of risk is related to the type of fund you choose. How the fundis managed also impacts the risk involved. There are two ways your fund canbe managed.Active management A highly experienced and specialised fund managerworks on your fund constantly to maximise the profits. They work closelywith a research team and use their insight and knowledge to decide on theshares that are most likely to give a return on your investment.Passive management Index Funds. They are called ‘Tracker Funds’ and arenot actively run by a fund manager. Their returns follow the performance ofa particular index for example the FTSE/JSE All Share Index (which measuresover 160 companies on our stock exchange). These are useful if you want toinvest in a certain type of company or sector as some indices track particularsorts of companies.How do you know which investment approach is best for you?Selecting a top quality active fund manager should, in the long run, providea better outcome than a passive strategy. However, this is not alwayseasy. In addition, investors must then guard against the natural instinctof switching. Prudential’s track record in South Africa does show that,provided the manager has a disciplined and robust investment process,active management will usually out-perform passive management over time.

I’ve decided I need to invest my money buthow will my portfolio or fund be managed?6

Here are four simple ways that you can use to make investingless risky.

1Invest in an equity fund rather than single shares. In this way,your money is a pooled investment alongside other investors and

managed by a fund manager. He ensures your money is spread across anumber of different companies, sectors and even regions to avoid all youreggs being in one basket.

2 Invest for the lon term. Ideally, you should plan to invest for atleast five or preferably 10 years. Markets tend to fluctuate over the

short term but over the longer term the peaks and troughs tend to besmoothed out.

3 Invest regularly. Investing at regular intervals can be a good idea asit is likely to mean the average price you pay for shares can be lower

than if you make one lump sum investment. Over time, regular investmentscan help to smooth out the peaks and troughs in the market.

4 Diversify your investments among different asset classes. Builda portfolio that includes higher risk investments like equities and lower

risk ones like bonds or even cash. The particular balance of your portfolio,or asset allocation, will depend on your expected return, your attitude torisk, your age and your longer term financial goals. Asset allocation is oneof the most important factors in investment success.

7 I can see how you can help my moneygrow but how do you help reduce theinvestment risk at the same time?

g

Asset allocation is the process of deciding how much money to invest ineach asset class.

To make the most of your asset allocation decisions, you first needan understanding of asset classes and the importance of strategic assetallocation.

There are four broad classes of assets available to you when building aninvestment portfolio: shares or equities; bonds; money market and cash andequivalents; and property.

It is important to have different asset classes in your investment portfolio totake advantage of the different strengths and characteristics of each class.

The characteristics of each asset class vary in terms of their differing levelsof income and the circumstance in which they may grow or fall in value.Some are easier to turn into cash (if you suddenly have unexpected expensesfor example) and they all have different levels of risk.

What is asset allocation?8

Asset allocation is basically the long-term diversification of yourportfolio between asset classes such as 60% to shares,

30% to fixed interest and 10% to cash. Ideally, this allocationshould match your longer term return and risk requirements.

As we noted earlier, for most investors, decreasing riskierassets like property and shares in favour of bonds and some

cash is a prudent course of action as you age.If you don’t wish to make asset-allocation decisions

yourself, then you should ask your financial adviser toassist you.

At Prudential, we offer a range of solution fundswhere we do the asset allocation on your behalf.

8 Prudential explains: When you buy a share, you are participatingin the ability of that company to grow in the future (or when theinvestment is in a fund, you want the profits of that basket of sharesin the fund to grow). There are many factors that influence howfast a company can grow, including the degree of competition in itsmarket segment, the strength of the brand, the soundness of companymanagement and so on. Companies differ in these regards. But onefactor that affects all companies is how quickly the economy itself isgrowing. For example, if consumers are spending more this is likelyto help companies increase their profits as they sell more goods andservices. Hence, over time, stronger economic growth should helpshare prices to rise. However, when economic growth is more robust,interest rates are likely to be rising. When interest rates rise, the pricesof bonds fall, so, in general, economic expansion will be worse forbonds. Blending equities and bonds into a portfolio can therefore helpto reduce overall volatility of your capital, as often when shares aredoing well (the economy is growing strongly), bonds will be performingless strongly and, of course, the reverse applies when growth becomesmore sluggish. Since economic growth ebbs and flows over time, inwhat many see as a very unpredictable fashion, deciding on a broadallocation between these two assets that you stick to over time canhelp smooth your returns.

Combining different asset classes in different proportions will helpyou achieve your investment objectives and take less risk to do so.

Fund Risk Profile/Asset Class

Min LumpSum

Min DebitOrder

IncomeDeclaration

PrudentialEquity Fund

High/Equity R10 000 R500pm June 30 andDecember 31

PrudentialDividendMaximiser Fund

High/Equity R10 000 R500pm June 30 andDecember 31

PrudentialBalanced Fund

Medium/Equityand Fixed Interest

R10 000 R500pm June 30 andDecember 31

PrudentialGlobal ValueFund of Funds

High/ForeignEquity

R2 000 R500pm June 30 andDecember 31

Prudential HighYield Bond Fund

Medium to Low/Fixed Interest

R10 000 R500pm Quarterly

PrudentialGlobal HighYield Bond Fundof Funds

Medium to Low/Foreign FixedInterest

R2 000 R500pm June 30 andDecember 31

PrudentialGlobal IncomePlus Fund ofFunds

Low/Fixed Interestand Equity

R2 000 R500pm June 30 andDecember 31

PrudentialInflation PlusFund

Medium to Low/Equity, Property,Fixed Interestand Cash

R20 000 R1 000pm June 30 andDecember 31

PrudentialMoney MarketFund

Low/Cash R50 000 N/A Accrued dailypaid monthly

PrudentialDividend IncomeFund

Low/Cash R50 000 N/A Accrued dailypaid monthly

PrudentialEnhanced SAProperty TrackerFund

Medium to High/Property

R50 000 R2 000pm Quarterly

PrudentialEnhancedIncome Fund

Medium to Low/Cash

R20 000 R1 000pm Quarterly

What funds are there and how muchdo I need to invest?

9

According to The Association for Savings and Investments Code of Practice 20070607Fund Classification for South African Regulated CIS Portfolios*, Portfolios are defined as:

DOMESTIC PORTFOLIOSThese are collective investment portfolios that invest at least 80% of their assets in SouthAfrican investment markets at all times.6.1 Equity PortfoliosEquity portfolios are collective investment portfolios that invest predominantly in shareslisted on the Johannesburg Stock Exchange. These portfolios invest a minimum of 75%of the market value of the portfolios in equities at all times and generally seek maximumcapital appreciation as their primary goal. All equity and derivative investments mustconform 100% to the defined investment requirement of each category. However,a) a minimum of 80% of the equity portfolio must, at all times, be invested in the JSESecurities Exchange South Africa sector/s as defined by the category, andb) a maximum of 20% of the equity portfolio may be invested outside the defined JSESecurities Exchange South Africa sector/s provided that these investments comply fullywith the category definition.6.1.1 Equity – General portfolios6.1.2 Equity – Growth portfolios6.1.3 Equity – Value portfolios6.1.4 Equity – Large Cap portfolios6.1.5 Equity – Smaller Companies portfolios6.1.6 Equity – Resources and Basic Industries portfolios6.1.7 Equity – Financial portfolios6.1.8 Equity – Industrial portfolios6.1.9 Equity – Varied Specialist portfolios6.2 Asset Allocation PortfoliosAsset Allocation portfolios are portfolios that invest in a wide spread of investments inthe equity, bond, money and property markets.6.2.1 Asset Allocation – Prudential Low Equity portfolios6.2.2 Asset Allocation – Prudential Medium Equity portfolios6.2.3 Asset Allocation – Prudential High Equity portfolios6.2.4 Asset Allocation – Prudential Variable Equity portfolios6.2.5 Asset Allocation – Flexible portfolios6.2.6 Domestic – Asset Allocation – Targeted Absolute and Real portfolios6.3 Fixed Interest PortfoliosFixed Interest portfolios are collective investments that invest in bond, money marketinvestments and other income earning securities.6.3.1 Fixed Interest – Bond portfolios6.3.2 Fixed Interest – Income portfolios6.3.3 Fixed Interest – Money Market portfolios6.3.4 Fixed Interest – Varied Specialist portfolios6.4 Real Estate PortfoliosReal Estate – General portfolios

Sector definitions

WORLDWIDE PORTFOLIOSThese are collective investments that invest in both South African and foreign markets. Nominima are set for either domestic or foreign assets.6.5 Equity PortfoliosEquity portfolios are collective investments that invest predominantly in shares listed onstock exchanges. These portfolios invest a minimum of 75% of the market value of theportfolio in equities at all times and generally seek maximum capital appreciation as theirprimary goal. All equity investments must conform 100% to the defined investmentrequirement of each category.6.5.1 Equity – General portfolios6.5.2 Equity – Varied Specialist portfolios6.5.3 Equity – Technology Sector portfolios6.6 Asset Allocation PortfoliosAsset Allocation portfolios are portfolios that invest in a wide spread of investments in theequity, bond, money and property markets to maximise total returns (comprising capitaland income growth) over the long term.6.6.1 Asset Allocation – Flexible portfolios6.7 Fixed Interest PortfoliosFixed Interest Portfolios are collective investments that invest in bond, money marketinvestments and other income earning securities.6.7.1 Fixed Interest – Varied Specialist portfolios

FOREIGN PORTFOLIOSThese are collective investment portfolios that invest at least 85% of their assets outsideSouth Africa at all times.6.8 Equity PortfolioEquity portfolios are collective investment portfolios that invest predominantly in shareslisted on stock exchanges. These portfolios invest a minimum of 75% of the market valueof the portfolio in equities at all times and generally seek maximum capital appreciation astheir primary goal. All equity investments must conform 100% to the defined investmentrequirement of each category.6.8.1 Equity – General portfolios6.8.2 Equity – Value portfolios6.8.3 Equity – Varied Specialist portfolios6.9 Asset Allocation PortfoliosAsset Allocation portfolios are portfolios that invest in a wide spread of investments in theequity, bond, money and property markets to maximise total returns (comprising capitaland income growth) over the long term.6.9.1 Asset Allocation – Flexible portfolios6.10 Fixed Interest PortfoliosFixed Interest portfolios are collective investments that invest in bond and money marketinvestments and those which seek to maximise interest and rental income.6.10.1 Fixed Interest – Bond portfolios6.10.2 Fixed Interest – Varied Specialist portfolios

* ASISA CODE OF PRACTICE, FUND CLASSIFICATION FOR SOUTH AFRICANREGULATED COLLECTIVE INVESTMENTS PORTFOLIOS 18 March 2008

David KneeBSc in Economics (London School of Economics)MSc in Economics (Birkbeck College)ASIP (Associate of the Society of Investment Professionals)

David is Head of Fixed Income at Prudential. In January2010, he also took on the role of Head of TAA. He joinedthe Prudential Group as part of the Fixed Income Teambased in London in 1997 and transferred to the SouthAfrican office at the end of 2008. Prior to working atPrudential, he managed fixed income portfolios foranother London-based asset manager.

Prior to working in asset management, in the early 1990s,he was employed as a Fixed Income Economist for anInvestment Bank.

Alongside his role as Head of Fixed Income and TAA,David is also a member of Prudential’s Asset AllocationCommittee.

profile

The views and opinions expressed by the independent authors and those providing comments are theirs alone,and do not necessarily reflect the views, opinions, or strategies of Prudential Portfolio Managers or any employeethereof. Prudential Portfolio Managers is an authorised Discretionary Financial Services Provider in terms of theFAIS Act, 2002. Collective Investment Schemes in Securities (CIS) are generally medium- to long-term investments.The value of participatory interests may go down as well as up and past performance is not necessarily a guide tothe future. CIS are traded at ruling prices and can engage in borrowing and scrip lending. A schedule of fees andcharges and maximum commissions is available on request from the company/scheme. Commission and incentivesmay be paid and, if so, would be included in the overall costs. Forward pricing is used. Fluctuations or movementsin exchange rates may cause the value of underlying international investments to go up or down. In calculatingperformance figures, initial charges are not taken into account (ie NAV-NAV). Annual service charges are deducted inall calculations. Dividends are reinvested on the reinvestment date at the reinvestment price. For more information,visit www.prudential.co.za or call 021-670-5100.