NFB Proficio Newsletter Issue 89

private wealth management

ROFICIO PNFB FINANCIAL UPDATE ISSUE 89 December/January 2017

FROM THE CEO’s DESK

I

t is common cause that Trevor Noah and others in the entertainment industry, particularly comedy and more specifically political satire, are overpaid, given the rich pickings offered daily by their scriptwriters! Writing this editorial makes me feel vulnerable to a reduction in reward as markets, politics and life in general certainly has been an exciting place, both in South Africa and beyond.

Before I launch into this edition’s commentary, I have some rather sad news to convey to our readers and particularly clients who have a long history of dealing with NFB. Nicholas Derrick Minnie, our retired Chairman, has passed away after a fairly lengthy period of illness. Derrick helped guide NFB and a very young executive through several years of growth.

He retired a few years ago and will be remembered for his role as a captain of the South African business market, a skilled rugby man and coach, as well as a coach to several young athletes in recent years.

Derrick is survived by his wife Rose, children and grandchildren. Our condolences go out to the Minnie family.

I have over recent publications spoken about human behaviour in various ways.

Central to this is always politics and the players. I have mentioned heroes and villains. I have also suggested that all is not lost and am often described as a 'glass half full guy'. I agree, and whilst we at NFB are, as previously noted, not keen on forecasting, believe that we might well be seeing stuff happening where the very brave are starting to win over the villains.

Seeing our new triumvirate of mayors in key metropoles getting down and dirty, cleaning up after other political parties' supporters damaged and littered in their constituencies. Also, getting fire engines

(close to my heart, as I grew up on the fire station in PE) back on the road. Not one of, but twenty-nine in Gauteng alone! I noted my wish for these new incumbents to apply Rudi Giuliani like tactics. It is early days, but my glass is feeling slightly more full!

Developments in the USA are to most folk astounding. I find it amazing how voters are expressing their anger and frustration at the status quo. Just take a look at Cameron's arrogance at proposing a poll (Brexit), and the Liberals nominating Hillary as their best shot, believing it was theirs to lose. It is both scary and hard to believe that these people also hold the keys to global nuclear arsenals! The people of the world, long dismissed as fuel and fodder, are saying enough! Politics has undergone a change and people are reverting to the old normal, or at least appear to be striving to do this.

Populists dominate all over and the next swathe of elections in Europe are the next opportunity for the unexpected to occur.

These rifts in the modern order are dangerous, however, and can cause large financial dislocation.

In South Africa much the same is happening, except it is being driven from the top. Recent resignations, talk of shebeens, victories in key metropoles, Thuli's last minute publication and the ripples this is causing are a few high profile examples.

In a recent presentation, a few points were made which got those present thinking.

Firstly, political change, labour dissatisfaction, downgrade risk in capital markets etc., are not unique to South Africa. These issues confront many countries. Another suggestion was that South Africa's poor recent economic performance is a consequence of both Global Economic factors and political

We are at another crossroad as a country.

This one feels as if the foot on the accelerator is changing for the better.

meddling, the latter representing as much as 30% of the problem. Should this be fixed and the trend towards a resurgence in Emerging Markets (of which we are one) be sustained, the next few years appear to be quite promising. Add to this that the devastating drought seems to be abating and the demand for basic resources appears to be rebounding and you start to see why the Rand has been showing it is not a one-way bet. This is not a new phenomenon, and has repeated itself three times over the last twenty years.

Economically, we are not in a great place right now. A few key drivers need to fall into place to change the mood of the consumer, the capitalist with money available to deploy and the economy at large. The psychology of the market is complex. We need stability more than anything. We also need a meddling government and administration to become a promoter, not inhibitor, of small and medium sized business. The engine room of growth in both developed and developing economies is big business, but the major creator of jobs, personal wealth and confident consumers is small and medium sized enterprises.

We are at another crossroad as a country.

This one feels as if the foot on the accelerator is changing for the better.

It is the end of the year and I would like to take this opportunity to thank every one of our readers and clients for your support over the past year and in many cases the past number of years. We would like to wish everyone well over the festive season and good fortune for the year ahead.

Mike Estment CFPÂŽ professional BA / Chief Executive Officer NFB Financial Services Group Gauteng

RISK ON …

RISK OFF In the current environment, is an investor being rewarded for taking risk?

W

e find ourselves in very interesting times where volatility has disrupted global markets and it seems this will continue for the short to medium term, with events like an interest rate increase in the US, Brexit, President Trump and our own battle to avoid being downgraded, all plaguing market sentiment.

The question everyone is asking is: where to invest? One thing history continues to prove is that there will be a lot of bumps in the short term, but these tend to get smoothed out over time and thus it is vitally important that one always remains a long term investor. The old saying “It's not about timing the market, but rather time in the market” remains true.

However, what I am addressing in this article is what an investor can look to in the current environment.

Let's first look at the favorite asset class of choice – equities. Equities are a great investment choice in that they provide an inflation beating return and good capital growth over the long term.

The graph below shows the current Price-to-Earnings (PE) ratio of the JSE. This is a ratio which gives one an indication as to whether the market is expensive or not. As you can see, the JSE has been in territory considered to be expensive for some time. This does not necessarily mean that there is going to be pull back in the short term, but with the companies on the JSE having negative real earnings growth on aggregate, we will most likely see a period of muted returns going forward.

Given that equities seem to be fully priced, coupled with the fact that markets are exhibiting excess volatility, where does that leave an investor?

We have been beneficiaries of an equity bull market for an extended period of time now and so strong capital appreciation has been what investors have become accustomed to. However, in the current low growth and low inflation environment yield becomes ever more important and something that will drive returns.

What do we mean by yield?

This would be the interest from money market instruments, the coupon from bonds, rental from property and dividends from equities.

The graph below shows the current yield of the various asset classes (right to left – equities; property; bonds; inflation).

When we compare the JSE to a number of developed world's PE's we see a similar trend. When compared to their long term averages, most markets, with the exception of Hong Kong, look to be relatively expensive. Once again concerns around global growth and earnings expansion may lead to a low returning environment across all these markets.

Given that equities seem to be fully priced, coupled with the fact that markets are exhibiting excess volatility, where does that leave an investor?

The interesting thing is that currently the South African 10-year government bond is yielding 9%. This means you can hold this bond to maturity and get an inflation plus 3% return, given the current CPI level of 6%. In a potentially low returning environment this is a largely attractive option for investors looking for stability. Looking at listed property, we can see that the yield is relatively low in comparison and this is in part a product of the robust capital appreciation this asset class has had over the last 10 years.

Therefore, we are left with a situation where bonds appear attractive. However, one must always remain cognizant of the risks involved in any asset class. The two most important such risks for investing in fixed income instruments are duration risk and default risk.

Duration risk is effectively the risk of your capital being affected by interest rate movements. A bond pays you a set interest rate from the issuance, split into bi-annual coupons. If interest rates increase it may be more favorable to be in floating rate instruments or to purchase newly issued bonds at higher yields, and as such, investors may sell the bonds to move into these instruments. This typically leads to a decrease in the capital value as downward pressure is exerted by sellers which results in the bond selling for a lower price to increase the yield and become attractive again to investors. The longer the time to maturity the more risk you run of interest rate movements affecting your capital. This is mitigated if you hold the bond to maturity as you will get your capital back. Due to this type of risk you find that most fixed income managers have a very low duration between 1-3 years which reduces this risk. This means they are currently more conservative and want to protect clients' capital.

The second risk is the chance of a default. This means the company, government or institution does not pay back your capital or only a part thereof. The price of this risk is factored into the yield offered by the issuer and the spread (excess yield over US treasuries of the same duration) is effectively the price of the increased risk of default.

What is then interesting to look at is international markets where we can compare the 10-year sovereign bond yield against the current dividend yield.

We can see that bond yields have been compressed right down through a series of expansionary monetary policies and the elevated desire for stable assets. Due to this, there is increased capital risk currently associated with global bonds; because of the inverse relationship between yields and bond prices, the scope for further yield compression is far less than that of a pickup in yields – and subsequent capital compression.

Jeremy Diviani CFP® professional B.Com Adv PGDFP, Private Wealth Manager NFB Gauteng

The converse to South Africa is therefore that equities are providing better yields than bonds internationally and in some cases even offer real (inflation beating) returns. The argument goes further in that some of the mega cap companies around the world like Nestle, General Electric and P&G who have been around through recessions and depressions and even World Wars may be sounder than some governments i.e. less risk of capital loss through liquidation or default. Internationally, it seems that bonds hold a lot of risk for little reward, and although equities are offering more reward it must be remembered that they are also not without risk.

So what does that mean to you the investor?

With the ever changing markets it is vitally important that in your portfolio you have exposure to a degree of active management, not only between the various asset classes, but also at a security specific level (i.e. within asset classes). In the fixed income space you would want a manager who is able to go up and down the yield curve i.e. allocate between short and long dated bonds based on where they see value. Furthermore, active managers are able to include corporate debt in a portfolio which may act to enhance the yield.

NFB Asset Management's Model Portfolios provide a further layer of pro-active management, further improving the investment process and making it more efficient. The table below shows the Model Portfolios performance over a number of time periods, measured against the various asset classes. What we can see is that not one asset class remains at the top throughout all the periods and that over the long term (5 - 10 years), growth assets typically tend to outperform i.e. equity and listed property. In the current environment the ability to combine the most appropriate mix is important.

Models vs Asset Classes

We are not advocating that one should be completely invested in one asset class and that bulk switches be made, but rather that in times of excess volatility and somewhat out of tune valuations, there is an increased benefit of active management. It is in times like this where the decisions of fund managers allow for a limitation of downside risk i.e. protect capital against large scale adverse market moves.

Finally, it is always important to talk to your trusted NFB wealth manager about your asset allocation and ensure you have the right mix of growth and yielding assets that match your risk profile and needs.

The old saying “It's not about timing the market, but rather time in the market” remains true.

DISCUSSING ESTATE DUTY A

s with a financial plan, a review of a client's estate planning strategies should be held on a regular basis, to determine whether the current strategies are still fulfilling your goals and are still in line with ever changing legislation.

= Repeal of the Capital Gains Tax (CGT) rollover between spouses,

followed by an increase in the CGT death exemption from the current rate of R300 000.00 to R1 million. = Following the repeal of the inter-spouse exemptions from estate

Over the past years and in accordance with its mandate, the Davis Tax Committee (DTC) has made several proposals to the Minister of Finance pertaining to our tax system as a whole.

duty and CGT, the committee proposes that the same interspouse exemption be reviewed for Donations Tax purposes, to ensure that there is no loop hole in tax.

The committee submitted its first report on estate duty in 2015, where it raised a couple of issues which, amongst others, included the issue concerning the decrease in estate duty collections by the South African Revenue Services (SARS).

Considering that donations between spouses is an everyday activity in some households, the exemption should only apply to assets that are not dutiable in terms of the CGT provisions, such as personal use assets and cash.

In August 2016, the committee submitted its second and final interim report on Estate duty. In the report the DTC touched on the issues it had raised in the first report and made further recommendations which amongst others include:

To ensure that the provision is not abused, a monetary limit will be set for personal use assets. For cash amounts, the “enduring benefit” rule will be applied, which will exclude amounts from Donations Tax provided they do not create a benefit which can be enjoyed for a period longer than a year. This will thus ensure that cash transfers are used for the maintenance of the family within a single year.

= The repeal of the inter-spouse exemption (Section 4(q)

deduction). This exemption makes it possible to exempt any bequeaths made to a surviving spouse from estate duty. The committee believes that the exemption excludes a lot of South African families and could discriminate against people on the basis of marital status.

Currently, donations made in anticipation of death are excluded from Donations Tax. The committee further proposes a removal of the exemption in order to discourage people from transferring their assets in anticipation of death.

= In the first interim report, the committee noted that the current

primary estate duty abatement of R3.5 million has not been increased in the past 9 years, and therefore should be increased to R6 million per tax payer - a recommendation which received a favourable response.

In the second report the committee adjusted its recommendation and proposed a R15 million increase in the abatement per tax year, regardless of a tax payer's marital status.

The implication of this proposal is that estate duty will be paid by high nett worth individuals.

Furthermore the committee proposes the removal of the interspouse abatement, in favour of the “one taxpayer, one tax return” principle. = Reintroduction of the progressive tax system for estate duty.

Nett estates higher than R15 million will pay estate duty at the current rate of 20%. Nett estates higher than R30 million will pay estate duty at an increased rate of 25%.

Although these recommendations are merely proposals for the Minister of Finance's consideration, they should be kept in mind in making estate planning decisions. Should they be tabled in a bill and later promulgated as legislation, they will have a huge impact on your estate plan.

Considering that a person's last will and testament contains most of the estate planning strategies, particularly where part of the estate is left to the surviving spouse, a review of the last will and testament and the holistic estate plan will need to be made. This review will look into whether your estate will be able to handle the estate duty burden which might arise, if these recommendations are promulgated.

Should you believe that your Will needs reviewing or that your circumstances have changed over the past few years, please contact one of our Private Wealth Managers on the following numbers: East London 043-735 2000 Port Elizabeth 041-582 3990 Cape Town 021-202 0001 Johannesburg 011-895 8000

Written by Phomolo Moreng

Should these recommendations be tabled in a bill and later promulgated as legislation, they will have a huge impact on your estate plan.

B.Juris (Financial Planning), PGDFP Financial Paraplanner NFB East London

East London Office: NFB House 42 Beach Road Nahoon East London 5241, Tel: (043) 735-2000 Fax: (043) 735-2001 E-mail: info@nfbel.co.za

Web: www.nfbec.co.za

Port Elizabeth Office:

Cape Town Office:

15th Floor, Metropolitan Building, Ground Floor, Building 6, 7 Walter Sisulu Avenue, Cape Town Ascot Office Park, Tel: (021) 202-0001 Fax: (021) 202-3888 Cnr. Ascot & Conyngham Roads, Email: info@nfbct.co.za Greenacres Tel: (041) 582-3990 Fax: (041) 586-0053 NFB is a licensed Financial Services Provider E-mail: info@nfbpe.co.za