Asset Allocation - preference shares as an alternative to corporate bonds?

[Ipodius]

Unfortunately in South Africa I don't have access to a corporate bond fund. However, I do have access to a preference shares ETF (essentially index fund) - http://www.grindrodsecurities.co.za/ETFS/PREFex.aspx

What would everyone's opinion be on using this as an alternative to corporate bonds? My current thinking on Asset allocation is as follows:

Government Bonds - 10%
Preference Shares - 7%
South African Equity - 45%
International Equity - 25%
South African Real Estate - 10%
Cash / Cash Equivalents - 3%

- Government Bonds will be 50/50 Nominal Bonds and Inflation Linked bonds, through a Index Tracking ETF
- Preference Shares - link above
- South African Equity - Index Tracking ETF
- Real Estate - Index Tracking ETF, index is 20 largest listed property funds.
- International Equity - half developed world, half developing world. Developed world is Index Tracking ETF following the MSCI World Index, developing will be a managed fund (unfortunately no Index Tracker available for this)
- Cash will be a Money Market Account.

My plan is to stay in South Africa, hence the focus on local equities. At the moment we are investing about 15%, in the next couple of years this will climb to 50% + once my wife is finished studying full time and I am finished studying part time.

I see today is apparently "Asset Allocation Week" - lots of questions on this topic! Maybe lets make a sticky with links to good resources on Asset Allocation and other "getting started" topics for those investors still starting out?

[alanwbaker]

Ipodius, the goal should be to own the whole (world) economy.  The South African economy is a small fraction of that, so why focus on South African equities?

[bigchrisb]

I'm also a believer in having a global portfolio.  I'm in Australia, which is some 2% of GDP and about 3% of global market cap.  However, I own a lot more than 2-3% of my assets in Australian investments.  I rationalize this by me intending on spending much of my life in Australia, hence expecting a large portion of future expenses to be in Australian dollars, moving up and down with the fate of the Australian economy.  Hence I'm significantly overweight in assets denominated in my local currency.

That said, even Australian listed companies have a lot of international earnings - I trawled through my portfolio's earnings by region from annual reports last year, and of my Australian stocks, 27% of their earnings were international earnings.

I suspect South Africa would be much the same. 

[Ipodius]

Good point alanwbaker, thanks for bringing it up - I've thought about it quite a bit and end up vacillating from one to the other.

On the one hand, I agree with you - I want to hold the global economy, and SA makes up a tiny fraction of that. Doesn't really make sense to be so heavily weighted in SA.

But on the other hand, as bigchrisb pointed out, I'm planning to live in SA long term, with all that that entails. We have a much higher inflation rate than internationally, and our currency is generally weaker. In theory over the long term the inflation rate and the currency depreciation are linked, but in the short term it's very unstable and un-correlated. The rand is very, very unstable vs international currencies [1] and there's potentially a lot of risk in having too much of my portfolio internationally. Would be nice if I lived in the US and didn't need to worry about this - 53% of the international equity market is made up of US equities. Also, as with Australia a lot of SA companies have significant foreign revenues - I haven't worked it out and a quick google couldn't find results, but I know that when the rand does poorly the JSE (Johannesburg Stock Exchange) gets lifted up due to a corresponding increase in the share prices of companies with large international dollar denominated incomes such as SABMiller.

So overall I feel like I know enough in this area to poke holes in the generalised advise I see online, but not enough to say for sure which way I should go. The advise I've heard from local investment advisors / financial advisors is to have more than half your equities in SA, but no-one has been able to give me a clear explanation for why that is the way to go. Anyone know of any good resources on this, either online or books? 


[1] 10 year US Dollar / Rand graph: http://www.xe.com/currencycharts/?from=USD&to=ZAR&view=10Y