Understanding Asset Classes, Part 1: What are equities, and what do they mean for me?

One of the main reasons South Africans don’t invest - apart from not having enough savings - is a lack of basic education on what investment choices are out there and what each one can do. This can act as a huge barrier to a wealthier, more successful future for many people. So in a bid to overcome this barrier, in this series on investing we introduce the basic asset classes, unpack how they produce returns and explain how investors can best benefit from each type. In Part 1 we start with a look at the most well-known asset class - equities.

Simply put, asset classes are a grouping of similar types of investments which are accessible to the investing public. The most fundamental asset classes are equities, bonds, listed property and cash (money market instruments). Here we answer some of the most commonly asked questions about equity investing:

So what are equity assets?
Also known as stocks or shares, equities represent a share of ownership in a company that you can buy. Unit trust managers generally invest only in companies listed on the stock market, which means that the company is publicly owned and its share price is published daily. Besides providing transparency, this makes it easily tradeable.

What determines the share price?
The share price depends on many factors: one of the fundamental drivers is the rate of profit growth produced by the company every year. Supply and demand on the stock market drive the share price on a daily basis, influenced by news, rumour and market sentiment. Shareholders make gains or losses depending on the price movement after having bought the share.

What are the benefits of investing in equity?
Equities around the world have historically produced the highest returns for investors over time, rewarding those who stay invested over the long term, meaning seven years and longer. In addition to the growth your investment can achieve as the share price rises, companies may pay dividends to shareholders, which represent a portion of the annual profit of the company. Dividends are generally paid every six months and can represent a steady income for investors.

How risky are they?
Equities are considered the most risky asset class because share prices are subject to large movements in the stock market on a daily basis, so that as an investor you can experience large gains or losses. This is referred to as “volatility”, or the degree of movement over time. The higher the volatility of a stock, or any asset, the higher its risk.

How do equity unit trust investments behave?
Unit trusts that invest only in equities are higher risk than those that invest in other assets. Their prices move further and the chance of loss is higher. Volatility (and risk) decreases over time, however – the longer you stay invested in equities, the less risky they are, since the chance of loss is reduced over time.

What does this mean for investors?
Equity investors need to have a longer-term investment horizon of about seven years or more, in order to fully benefit from their equity holdings. They should therefore have a longer-term investment goal - like retirement - and be willing to ride out the ups and downs of the equity markets, ignoring the short-term news flow. Those who switch in and out of the market frequently have been shown to earn lower returns over time.

Prudential offers investors two unit trusts with an equity focus: Prudential Equity Fund and Prudential Dividend Maximiser Fund, both of which are ranked in the top 25% of their peer group over 10 years.

In the next part of this series we will be looking at bonds, how they produce returns and how they can benefit you as an investor.

If you aren't already investing with us, contact your Financial Adviser or our Client Services team on 0860 105 775 or at info@prudential.co.za