Category Archives: Finance

The critical role of a consultant in umbrella funds

Sanlam Employee Benefit’s head of special projects David Gluckman penned the following in response to a recent article published as part of a Sygnia marketing campaign.

Consistency is the only currency that matters” is a well-known slogan of one of South Africa’s leading asset managers.

At the other end of the spectrum, a new player entered the commercial umbrella fund market less than 4 months ago proudly announcing “one all-in fee as a percentage of assets under management” and illustrating projected cost savings to clients adopting this model versus the competing leading commercial umbrella funds. Besides some fees such as costly hedge funds being over and above the so-called “one all-in fee”, importantly all these projections assumed there would be no need to separately pay for the services of a consultant. Today the message is slightly different and we should now understand that these projections were never accurate in that the true intention was always to leave “financial room for the employment of independent consultants.”

Two recent experiences highlighted to me that a very important question to explore is what will in the future be the role of the consultant in commercial umbrella funds.

  1. One highly respected independent consultant to a large book of Sanlam Umbrella Fund clients (and who also has many clients participating in other major commercial umbrella funds) raised the issue with me at our 2016 Sanlam Employee Benefits Benchmark Symposium, and said he is worried about the sustainability of his business given the increasing power of the major commercial umbrella fund sponsors.
  2. Various senior Financial Services Board officials also raised the matter in an April 2016 workshop with Sanlam Umbrella Fund representatives, essentially asking whether consultants introduce an extra and unnecessary layer of costs. They wanted to explore whether Sanlam could instead provide these advisory services thus savings costs for the ultimate clients of umbrella funds being the members.

The Sanlam Umbrella Fund governance model was structured consistently with thinking as set out in my paper entitled “Retirement Fund Reform for Dummies” presented to the Actuarial Society of South Africa as far back as 2009. In that paper I argued:

The role of intermediaries (aka consultants) requires particularly close scrutiny. I would argue their role is a particularly vital one if we want to create a culture of effective competition.

Rusconi argues “In the institutional space, however, savings levels are less likely to change and marketing is more about attracting another provider’s customer than about motivating additional savings”.

Such arguments emanate from the premise that intermediaries do not add value to consumers – an assertion that I would challenge. My view is that there are both good and bad intermediaries, and we need to find a model where market forces will push in the direction of forcing intermediaries to continually “up their game”.

The difficulty in determining cost effectiveness

Determining what added value you get when you pay above-benchmark investment fees for your collective investment scheme is similar to weighing the cost-effectiveness of a luxury German sedan against a Korean family car.

Will you get enough additional value from the investment to compensate you for the extra money you have to pay? Put simply, will you get bang for your buck?

If a fund delivers a 100% return during a particular year, an investor will probably have no problem sacrificing 10% of the return in fees. But if the return was 11%, forfeiting 10 percentage points in costs would make no sense.

This is probably the most important point in evaluating the fees you pay for your collective investment, says Pankie Kellerman, chief executive officer of Gryphon Asset Management. It is not about the absolute quantum you pay, but about what you buy for it.

The impact of costs

Calculations compiled by Itransact suggest that if an amount of R100 000 was invested over 20 years at an investment return of 15% per annum (inflation is an assumed 6%) at a cost of 1%, the investor would lose 17% of his returns as a result of fees. If costs climb to 3%, the investor would sacrifice almost 42% of his returns.

Unfortunately, it is not always that easy to get a clear sense of what you pay and what it is you pay for, but the introduction of the Effective Annual Cost (EAC), a standard that outlines how retail product costs are disclosed to investors should make this easier.

Shaun Levitan, chief operating officer of liability-driven investment manager Colourfield, says the time spent looking around for a reduced cost is time worth allocating.

“I think that any purchase decision needs to consider costs, but there comes a point at which you get what you pay for.”

You don’t want to be in a situation where managers or providers are lowering their fees but in so doing are sacrificing on the quality of the offering, he says.

“There tends to be a focus by everyone on costs and [they do] not necessarily understand the value-add that a manager may provide. Just because someone is more expensive doesn’t mean that you are not getting value for what you pay and I think that is the difficulty.”

Costs over time

Despite increased competition and efforts by local regulators to lower costs over the last decade, particularly in the retirement industry, fees haven’t come down a significant degree.

Figures shared at a recent Absa Investment Conference, suggest that the median South African multi-asset fund had a total expense ratio (TER) of 1.62% in 2015, compared to 1.67% in 2007. The maximum charge in the same category increased from 3.35% in 2007 to 4.76% in 2015. The minimum fee reduced quite significantly however from 1.04% to 0.44%.

Are financial services companies missing the point of savings month

July is savings month in South Africa. This is an initiative that is meant to encourage us all to be more serious about putting away money for our futures.

The premise is obvious. South Africa’s savings rate is abysmal and we need to do something to fix that.

However, many of the messages coming from financial services companies this year have not focused on the country’s savings habits. They have rather been about our spending habits.

Sanlam, for instance, has collaborated with rapper Cassper Nyovest and actress Pearl Thusi on a project called #ConspicuousSaving. The two, who are usually known for their big spending, have been posting on social media about doing things like home facials, clothes swapping or a haircut at a roadside barber to save money.

At a media luncheon in Cape Town on Thursday, Liberty also looked at ways in which South Africans might try to moderate their spending. Based on the findings of a survey conducted by Alltold, Liberty showed where consumers look to cut back to make their money go further.

The primary lesson from the study, entitled The Frugality Report, was that South Africans don’t like to compromise on their lifestyles. Even when they are spending less, they don’t want to cut anything out. They just look for more cost-effective ways of doing the same things.

This suggests that South Africans are probably too attached to the kinds of lifestyles they want to lead. They aren’t willing to seriously assess what they spend their money on and how much of it is really necessary.

In isolation, there is nothing wrong with highlighting these issues and questioning our spending habits. The first step towards financial freedom is always spending less than you earn.

However, it is only that – a first step. Only encouraging South Africans not to spend so much doesn’t really address the key issue of savings month, which is how to get more people to save more of their income.

Even if one of Thusi’s Twitter followers does heed the message and saves money by doing her own nails, buying second-hand clothes and turning down the temptation to buy a new handbag, what then? What does she do with the extra money that she now has?

This is where the financial services industry itself needs to do some serious introspection. It is simply not doing enough to make it easy and cost-effective for South Africans to save and invest.

Even acknowledging that this is not a simple thing to do, it doesn’t feel like too many companies are really trying very hard. The level of innovation in building simple, appropriate and appealing products is poor.

Even some firms that already have options that could be used to attract first time investors don’t market them as such. For instance, the Stanlib Equity Fund may be the only unit trust in the country that accepts debit orders of just R50 per month, yet I am not aware of any advertising from the company that has ever centred on this fact.

Easy Equities is a rare exception trying to make investing exciting and accessible, but why has it remained an outlier? Why aren’t more companies looking at ways to do similar things?

Many of them will say that it’s not easy when faced with the amount of regulation involved, and there is truth to that. However, this is not insurmountable. There are already online platforms that allow an investor to complete, sign and submit all the documentation they need for an investmentment online and simply upload their Fica documentation. It’s a process that needn’t be burdensome on the consumer.

It is indisputable that the level of financial education in South Africa needs to improve. It is also clear that we need to reconsider our spending habits.

The next ratings decision before investing

In this advice column Mikayla Collins from NFB Private Wealth answers a question from a reader who wants to know whether his advisor should have held back on making any investment decisions until the ratings agencies make a decision on South Africa.

Q: I just a made an investment of R400 000 via a financial planner who placed these funds within a unit trust portfolio.

My question is twofold:

Firstly, if we are downgraded to “junk” status, is there any possibility of me losing my investment or the investment not yielding the promised dividends?

And, secondly, should I have waited or should the financial planner have advised me to hold on with the investment, pending the outcome of the ratings decision later this year?

The first likely result of a downgrade would be further depreciation of the rand. This would be brought on by foreign investors selling their local assets and taking their money out of South Africa.

To understand how this would affect your personal portfolio, you need to look at the breakdown of the underlying assets and how the portfolio is split between local and foreign assets. A weaker rand means that the foreign holdings would look better, as they would be worth more in local currency terms. In addition, since many of our locally-listed shares are also rand hedges (around 70% of the market cap of the JSE), it’s likely that a large portion of your local holdings would also be protected.

On the other hand, some local assets would suffer as a result of rand weakness. However, since a downgrade would be a well anticipated event, it is most likely that the fund managers with whom your advisor has placed you have adjusted their portfolios accordingly.

Secondly, it is important is that you understand the difference between the long-term and short-term impacts a downgrade might have. Depending on your particular plans and requirements for this investment, your advisor should have selected funds that suit you for the time period you are looking to invest.

Assuming that you are investing for the long term, the bigger threat to your investment is not the immediate effect that a downgrade would have, but more what it means for the long-term economic prospects of our country. A downgrade to junk status would be a confirmation of what we have been hearing for a long time – that our growth and inflation prospects are poor, and that despite the threat of a downgrade with plenty warning, we have been unable to prevent this from happening.

This is a difficult environment for any company to operate in, and the expectation would be that it will result in lower earnings and therefore lower dividends in future for those who operate only locally. This would negatively affect share prices. Once again, you can avoid having too much exposure to local assets by having a large foreign or rand hedge component in your portfolio, but that also opens you up to the risks of other countries and currencies.

What your advisor and fund managers will most likely have done is to take account of the impending downgrade and act appropriately. Junk status or not, your investment should be well diversified so that when certain assets weaken, others will strengthen.

Keep in mind that our own ratings downgrade is not the only risk to your investment and probably not the biggest risk either. Consider how our own markets seem to follow international events more closely than local ones.

This brings me to the second part of your question regarding whether or not you should have waited. The answer is no. It is never a wise decision to delay investing to try to time the market.

The gift that keeps on giving

This time of year sees both children and adults preparing their wish-lists for the upcoming festive season. But as many South Africans continue to grapple with rising debt, now is a good time to shift the focus from giving material items to providing future financial well-being.

Giving a child an investment as a gift will not only promote a culture of saving from a young age, but will also show them how you can make money grow.

There’s a powerful story of one customer’s commitment to leave a legacy for his family, and the value of sound financial advice. In November 1968, a customer made an initial deposit of  R400 into the Old Mutual Investors’ Fund and 48 years later, his investment is today worth over R600 000.

More precious than the value of his money, however, was the culture of saving and the legacy that he passed on to his children and grandchildren. On special occasions such as Christmas and birthdays, he invested a set amount of money on his children’s or grandchildren’s behalf. With this investment, his daughter was able to provide for her daughter’s schooling.

If South Africa is to develop a generation of financially savvy adults, it is crucial to not just talk about it, but actually practise good money habits. It is important to teach your children about money, and the festive season – with the spirit of giving – is a good time of the year for parents to set a good example. Teach your children about the importance of giving within your means, as well as showing them the value of relaxing with family and rewinding after a long, hard year, while respecting the value of hard-earned money.

Families should consider starting a financial tradition of their own. Set a reasonable budget for gift giving this festive season, and instead of spending all your money on gifts that are likely to fade, go missing or be forgotten, speak to your financial adviser about starting an investment in the name of your children.

When children become old enough to understand more about money management, parents should involve them in the process. Teach them the principle of compound interest and explain why putting money away today means they will have more money tomorrow. Help them set a budget for the money they’ll receive over the festive season, encouraging them to spend a smaller percentage today, and investing the rest for the future

Options at retirement

Q: I will retire at the end of October 2016 from government service. I have the option of a retirement gratuity of R1.2 million plus a monthly pension of R 27 414 for life, or a resignation benefit of R5 047 648.

The downsides of taking the annuity option are that when I die the monthly pension that will go to my wife will halve; and that when she dies, the pension stops altogether and nothing will go to our children. I’m also worried by the current political landscape in South Africa whether I can have peace of mind with regard to how the GEPF will be managed in future.

My question is this: If I rather take the resignation benefit of R5 047 648, can I obtain a monthly income comparable to the monthly pension of R27 000 plus the yield on the investment of the R1.2 million gratuity through investing this amount?

The reader belongs to the Government Employees Pension Fund (GEPF), which is what is called a defined benefit fund. The retirement benefits are therefore defined with regard to the reader’s salary at retirement and the length of service at their employer.

Let us consider the two options that the reader has presented in more detail:

Receiving an annuity for life

The reader will receive an annuity, for life, which begins at R27 414 per month. On death, the spouse would continue to receive 50% of this annuity for the remainder of her life.

Pension increases are also usually granted annually by the GEPF in line with their policy which targets 100% of CPI. The reader is also entitled to a gratuity lump sum at retirement of R1.2 million.

Under this scenario, the GEPF, assumes the investment risk. In other words, the member will continue to receive their pension, irrespective of how the underlying investments perform.

The GEPF also assumes the longevity risk, or the risk of the member and their spouse living longer than expected. As an extreme example, if they both lived to 120 years, they will continue to receive their pension. On the other side of the coin though, if they both pass away shortly after retirement, no further payments will be made and any children dependants will not receive any lump sum payment.

Taking the lump sum and investing it

The reader states that they are entitled to R5 047 648 as a resignation benefit. For purposes of this comparison, the impact of tax on this amount has not been considered as this could vary by individual.

Let us assume that this money will be invested into a living annuity-type structure in order to provide a retirement pension. Under this scenario, the lump sum is invested and a pension is drawn from this balance for as long as the balance is positive.

To put it simply, this operates similar to a bank account. The account increases with investment returns and reduces by any amount that the reader withdraws in the form of a pension.

It is important to realise that the reader will be assuming both the investment and longevity risk under this scenario. Poor investment performance will impact on the amount of pension that the reader may be able to withdraw. Additionally, if the capital is fully eroded while the reader is alive, no further pension will be payable. However, on death, the balance of the account can be paid out to the spouse or other dependants.

Invest or put money into your bond

In this advice column Alexi Coutsoudis from PSG Wealth answers a question from a reader who wants to know what to do with a lump sum investment.

Q: I have R100 000 in a unit trust. At the same time I have an outstanding bond. Would it be better to remove the funds from the Investment and offset part of the home loan?

Advisors are frequently asked this question. This often has more to do with personal risk preference than with economic rationality. To answer this question, however, certain assumptions must be made, and I specifically won’t look at tax to keep the answer succinct.

The rational answer

Let us assume that the interest rate on the bond is at the prime lending rate. That is currently 10.50%

The second assumption we need to make is about what the risk level of the unit trust in question is. A money market unit trust has a very different risk and associated return goal than an equity unit trust.

A low-risk money market or income fund aims to beat inflation and offer a real return of 1% per annum. Thus, if the R100 000 is in an income unit trust only yielding 7% to 8%, it would be rational to secure the higher guaranteed return of 10.5% and transfer the funds into the bond.

However, if the money is in a balanced fund which generally targets a 5% real return, it would be more rational to remain invested as the real return is in excess of the bond interest rate.

It is also important not to fall into the trap of looking at the short-term underperformance of equity linked funds in a time like now and compare this to a resilient prime rate. This may result in the wrong decision to sell out at the wrong time. Every situation is unique and the best course of action is to get advice from a financial advisor who will look at the big picture and your individual circumstances.

The subjective answer

The other way I would advise a client on this is a more subjective approach – the sleep test. Quite simply, what makes you sleep better at night? Would that be a bond balance of R100 000 lower than it is now with no funds invested, or the same outstanding bond balance but R100 000 invested?

The answer will be different for each individual and there are a lot of factors that influence one’s financial decision making such as your view of debt as either toxic or as an enabler. For some people having R100 000 invested offshore, for example, gives them comfort. Therefore, because the economic rationality argument is often such a close contest, considering the subjective approach may help make the final decision easier.

Withdraw your retirement benefit

Q: I am 39 years old and have worked for the public service for just over 11 years. I am considering resigning because I want to further my studies for the next three years.

My current retirement fund value is R947 113.

How much will they tax me if I take this out and how best can I invest it?

The short answer to your question is that you will be paying R191 820.51 tax on a retirement fund value of R947 113. In other words, 20.25% of your retirement benefit will be paid to the South African Revenue Service (Sars).

How this is calculated is that your capital will be taxed on a sliding scale. The first R25 000 is tax free, the next R635 000 will be taxed at 18% and the balance will be taxed at 27%. Although not relevant in this instance, any amount over R990 000 would be taxed at 36%.

However, you can avoid this tax entirely by transferring the benefit to a preservation fund. This is an option you should seriously consider.

A preservation fund works in the same way as a retirement fund, except that you don’t have to keep contributing to it. You will be able to make one withdrawal from this fund before your retirement date, but otherwise you won’t be able to access the money until you turn 55.

Once you retire from the fund, the first R500 000, less any amount you have already withdrawn, will be paid out tax free. At this point you can withdraw up to one third of the capital as a lump sum if you like, but the rest must be used to arrange a monthly income during retirement. You will be taxed on your monthly income according to Sars income tax tables.

Why this is particularly important is because if you withdraw your retirement capital now, the R500 000 tax-free benefit that you would receive when you actually retire will fall away. So you will be suffering a double tax penalty.

Apart from the tax you will have to pay now, you should also consider the important differences between putting the money into a preservation fund and taking it out to invest yourself.

Applications affect on your credit score

There is a view among many South African consumers that applying for a bond at more than one bank will have negative consequences. The belief is that these enquiries will impact on your credit score and therefore hurt your chances of getting a loan or push up its cost if you are successful.

Many people only apply at their own bank for just this reason. They think that they are taking a risk if they shop around.

This raises some obvious concerns. After all, you are only exercising your rights as a consumer to compare prices, so why should you be penalised for it?

Footprinting

What is a given is that every time you apply for a loan of any sort, this will be recorded on your credit profile. This is called footprinting, and credit providers may use this information to assess you.

“Credit providers consider a multitude of factors when vetting applications for credit, one of which would be demand for certain types of credit,” explains David Coleman, the head of analytics at Experian South Africa. “A sudden surge in demand for unsecured or short term credit, linked with signs of stress building on indebtedness and repayment capacity of the consumer, would result in the credit provider taking a more cautious approach in extending further credit to such a consumer.”

However, short term credit is not the same as long term credit like a home loan in this regard. In fact, Nedbank says that it views multiple applications for a bond made at the same time as a single enquiry.

The head of credit for FNB retail, Hannalie Crous explains that they also make a distinction:

“From an FNB perspective we do not look at number of bureau enquiries pertaining to home loans as a key determinant of a credit score,” she says. “The handful of credit bureau enquires associated with a bond application will have no effect, however  a consistent trend indicating that a consumer is taking on multiple loans could influence the outcome of a credit application.”

Not all bureaus will see you the same

In other words, the banks don’t see it as a negative if you shop around for a bond. A number of credit bureaus approached by Moneyweb also took the same line, although with a caveat:

“Each credit bureau and each credit provider that has their own in-house score will score consumers using their own criteria,” says Michelle Dickens, the MD of TPN. “It’s not a one size fits all. As a result there will be a higher weighting towards different aspects of data that will improve or decline the ultimate overall score.”

The head of the consumer bureau at XDS, Alex Moir, explains that different companies may therefore use information differently.

“Not all credit bureaus will use the application data in the credit scores, which means that a customer could go to as many banks as they like and their risk score with these bureaus would not be impacted,” he says. “Some credit bureaus do however use the application data and, in this instance, the consumer’s score could actually be impacted positively if they do enquiries at different banks. There is generally a threshold that some of the bureaus would have, where making one to three enquiries would add points to your score, three to five enquiries would leave the score as is and more than five could deduct points from your score.”

Moir adds that he believes this is a legacy from when these scorecards were developed and there was not much data available. Therefore any data that was supplied got used. However, this should now be the exception.

“Where you have a consumer with a lot of information such as a number of accounts with payment profiles, there’s enough other data to make an assessment,” says Dickens. “But when there is not a lot of other information, then the weighting could lean more towards the footprinting.”

She adds, however, that what bureaus can’t do is give you a bad score just because they have nothing to go on.

“One of the things the scores can’t do is

Old Mutual Investment Group

Old Mutual Investment Group sees domestic equities, property and bonds delivering higher returns in 2017, on the back of improving economic prospects.

It expects peaking interest rates and inflation in South Africa to create a positive environment for interest rate sensitive assets such as domestic property and bonds.  It sees inflation averaging at 5.4% in 2017 compared with 6.3% in 2016 and the benchmark repurchase rates falling to 6.5% by the end of 2017, down from 7% currently.

According to Peter Brooke, head of Old Mutual Investment Group’s MacroSolutions Boutique the 13.5% return on domestic bonds year-to-date as at November 24 2016 is artificially high due to an oversold bond market.

Instead, he said SA cash – with a 6.8% return in rand terms – is the best performing local asset class thus far. SA listed property delivered returns of 4% and the FTSE-JSE Share Weighted Index (SWIX) returned 2.5% over the same period.

After starting the year with the highest level of cash in its fund ever, the group is seeing more opportunities in equities as the domestic equity market de-rates.

“We’re not at the stage where the JSE is cheap yet. It is on a 13x forward but it does offer a real return in the region of 5%. We’re not back to levels that we have enjoyed for the last 100 years of around 6.5% but value is starting to incrementally rebuild,” he said.

As a result, the group upped its long term expected real returns on SA equities from 4.5% to 5% and SA property from 5% to 5.5%.

“When we look at a balanced portfolio and we just use our static benchmark, in other words a passive offering, the expected real return on a balanced fund has picked up to 4%. It is the first time it has been at the 4% level in two and a half years, so we are starting to see a little bit of a better return coming through,” he said.

The group also warned against “excessive pessimism” over the South African economy as its prospects start to look up.

“Load shedding is long past, commodity prices have stabilised and have actually recovered a bit, rainfall is improving, the food inflation shock will reverse in the months to come and the labour environment has stabilised notably this year,” said Rian le Roux, chief economist at Old Mutual Investment Group.

He added that the National Treasury’s commitment to fiscal consolidation is expected to reduce pressure on monetary policy and lead to a lower interest rate from mid-2017.

The group has forecast GDP growth of 1.3% for 2017 but warned that improvements are likely to be slow due to the strained consumer environment, depressed business confidence, low levels of private investment and an expected rise in taxes.

Still, the expected improvement in global economic growth is likely to provide some support. However, a potential break-up of the Eurozone, a hard landing in China, aggressive interest rate hikes in the United States and domestic political uncertainty remain risks.