Page 129 - Profile's Unit Trusts & Collective Investments - March 2025

Understanding Asset Allocation

Preference and Other Shares
When people talk about buying shares, they usually mean the ordinary shares of listed
companies. Ordinary shares, known as common stock in the US, are the most popular
equities because their rights are simple and clear-cut. But they are not the only kinds of
shares. Preference shares, for example, usually entitle the holder to a prior claim on dividends (ie,
before payment is made on ordinary shares), but often don’t have any voting rights. Many
preference shares effectively pay a fixed rate of interest subject to the profitability of the company.
Subject to shareholder approval, companies can create different classes of shares with different
dividend rights and different voting rights. Non-voting “ordinary” shares (called N-shares) were
popular on the JSE in the 1980s because they allowed controlling shareholders to raise capital
without the risk of losing control of the company. They have the same ownership and dividend rights
as ordinary shares.

Equity-based investments reward investors in two ways: they offer capital gains as the share
price increases, and they offer dividends, which is the portion of profits that a company chooses to
pay to shareholders.
Underlying Investments of Equity-Based Schemes
The bulk of equity investments held in South African collective investment schemes are
ordinary shares listed on the JSE and some overseas stock exchanges. Ordinary shares represent
ownership in a limited liability company, entitling shareholders to dividends paid by the company.
Usually, each ordinary share carries a single vote. Shareholders appoint company directors at an
annual general meeting, and the directors of large companies act (or are meant to act) in the
interests of shareholders.
Shares are such popular securities around the world becausetheygiveinvestors asimplemethodof
participating in the wealth-generating potential of big businesses. Shareholders are part-owners of a
business, no matter how small their stake, and they ultimately share in the profits of the business.
Growing companies offer profit potential unequalled in other areas of investment. There are
many examples of shares that have grown tenfold in a decade, and many listed companies can
sustain growth rates of 30% p.a. or more under the right economic conditions. It is these
outstanding returns that maintain investor interest in equities.
Unfortunately, businesses are complex, and predicting which companies will make big profits
and keep growing is notoriously difficult. When it comes to equity markets, there is also the very real
risk of investing in a business which goes bankrupt, leaving shareholders with nothing. It is this high
risk/high return character of equity markets which makes them so volatile and unpredictable.
It is the riskiness of individual shares which makes the principle of diversification so important for
stock portfolios. Collective investments which hold broad-based portfolios are therefore an ideal way
for smaller investors to achieve adequate diversification across equity sectors.
Equity markets are influenced by the business
cycle, although stocks often lead economic trends,
recovering ahead of the economy at the end of a
recession, and peaking before the economy during
periods of economic growth. Stock markets are also
prone to “herd” behaviour, one of the factors giving
rise to sustained bull and bear markets. In simplistic
terms, market optimism tends to carry all shares
higher, and pessimism tends to drive all shares
lower, downplaying the riskiness of shares when
times are good and overemphasizing the negatives
when times are bad. It is the tendency of equity
investors to cyclically overvalue and undervalue
stocks that necessitates long-term positions in order
to reap the benefits of equity markets.

Profile’s Unit Trusts & Collective Investments — Understanding Unit Trusts 127