NFB FINANCIAL UPDATE Issue64 October2012
FROM THE CEO’s DESK
W
hy does Mr. Malema keep popping up? Probably because I would suggest the ANC are so busy fighting and jostling for position, influence and survival at an individual level, that scarce attention is being paid to very dangerous and manipulative forces, alienated by themselves and left to their own screwed up devices. I noted several years ago that the danger with politicians was their tendency to think in terms of short term cycles, not surprisingly accurately matching election cycles. This short termism has resulted in damage beyond comprehension and manifests in attitudes that, unfortunately, aren't restricted to this venerated part of the new S.A. It has spread like wildfire to the most vulnerable parts of our population, creating a sense of desperation and expectation, easily exploited by the likes of those in search of power, and potentially protection from the law ( - important given past indiscretions) by becoming the de facto law makers. I mentioned recently that whilst Mr. Malema was not a model student, he was by no means stupid, and once again, this is being borne out in his recent actions. He is tuned into the psyche of the masses, happy to stir the pot with scant or no regard to the societal impact. He has embarrassed the incumbent government and organised labour, made promises that he has no way of delivering on and is getting an extraordinary amount of attention from global media, who are always in search of controversy and chaos. This backdrop, whilst potentially manageable worries me and it is indeed these issues which are referred to when the market talks about the importance of diversification both by geography and sector. Concentrated risk is when too much money is focused on only one, or a few, investment alternatives. In South Africa this has been amplified by the historical limitations imposed by Exchange Controls. To a large degree this has been reversed by the significant relaxations introduced over the last few years, making it possible for South Africans to materially diversify investments across global and local bourses, stocks, banks and other investments, making genuine diversification both possible and relevant. This decision is complicated by the difficulty in motivating exactly what to invest in, given the confused state of economies, governments, currencies and markets. Offshore property, which in SA has been a star performer, has seen losses, vacancies, oversupply and generally has been a
terrible asset to have held. And although recently showing some sustained positives, global bourses have disappointed. Cash is desperate in the developed markets, in most cases offering net returns where investors are "paying" the bank to hold your money, and bonds offer low yields and capital risk should current cyclically low rates push higher. Notably, this is also taxable in our hands. A well known global personality recently summed it up brilliantly in saying that today's investors are paying the price of yesterday's reckless borrowers (for Borrowers read, Governments, Banks, Regulators, etc). Another cynical comment I heard, was that the return you received for putting your money in the bank used to be called the Risk Free Return. It's now called the Return Free Risk! We have access, both directly and via a few major business partners, to investments into major offshore shares, and interestingly South African Bank's offshore bonds. These can now be wrapped in an offshore issued product which will achieve tax free returns for South African investors. This opportunity is directed to investors who are prepared to invest for growth with acceptable volatility and risk. For those who do not have the stomach for risk we have solutions which guarantee a tax free return, backed by Major International Banks and corporate, together with moderate (50%) participation in one of two Global indices. The details and relevance of these investments for your portfolio needs careful discussion with your advisors at NFB. This editorial is not intended to urge you to pack for Perth, but it certainly is intended to prompt you to discuss recent developments, revisit what offshore assets are doing, and take advantage of very important tax advantages and a range of solutions which seem to me to be obviously worth some consideration. Overseas investments need to stand on their own. Weakness in the rand, or worse still, major volatility caused by local political or social events, will add to returns (- when measured in rands). I hope I am proved wrong about my expressed misgivings, but as a noted patriot, I have seldom felt the powers that be are losing the plot as currently is the case. Caveat Emptor.
Mike Estment, BA CFPÂŽ CEO, NFB Financial Services Group
IN THIS ISSUE From the CEO’s desk Cash, inflation and growth assets Estate duty
financial services group
CASH, INFLATION AND GROWTH ASSETS
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What can investors do in this low interest rate and low inflation environment to give their portfolios a reasonable chance to enjoy real returns? By Jeremy Diviani, NFB Gauteng, Private Wealth Manager
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We find ourselves in an interesting investment environment: the local JSE is at an all-time high; global investors remain nervous around Europe; the US with economic data indicates a stalling economy that is still trying to find its feet; and lastly, most central banks are ready to hit the printing press button and push more capital into their economies as further easing seems to be the order of the day. In this environment investors typically turn to safe havens like gold, cash and money market. Historically cash-like investments have given South Africans real returns, but no longer as we find ourselves with a zero or negative real rate of return. Most central banks have indicated that low interest rates will be around for extended periods of time and thus this is a problem not in a hurry to leave.
What is a real rate of return? This is when you are in an investment and your net return is above that of the inflation rate. The danger of a negative real return is that you lose purchasing power and even with a capital increase you cannot buy the same amount of goods next year as you did this year. Some investors have remained in cash or money market funds waiting for signs of a recovery and an opportune time to switch into growth assets. This may not come for the next 3, 5, 7 years or longer so it is important to illustrate current investment options. The first graph indicates that currently the real return from a money market fund (money market funds typically have a return in excess of cash) is marginally positive. We have used CPI as a proxy for inflation, however, some may argue that this is below actual inflation with food, medical aid, and electricity costs all rising substantially in excess of CPI.
Source: I-Net Bridge As an aside, inflation is not at its high currently being around 4.9%. With the South African economy struggling, and with inflation in its target range, the Reserve Bank may cut rates further and in so doing, reduce this real return. A second thought is to consider the following situation where someone is retired and drawing an income of say 5% of the portfolio: his or her real return is -5% (assuming a return of 5% and inflation of 5%). In a situation like this we sometimes get asked if the capital is going backwards, however, in reality the capital value would remain flat, but the purchasing power is being eroded almost like a “silent assassin�. One solution is to have saved more than necessary in your build up to retirement, so you do not have to worry about these matters. However, there are not too many who can afford this luxury and it is thus important to understand what one can do to rectify this. If someone is retired then
they can try to reduce their costs and thus portfolio drawings, and for those in the pre-retirement phase of life it is important to save more to ensure a sustainable retirement. In both scenarios it is necessary to take on a certain amount of growth assets in a portfolio that should, over time, provide an inflation hedge. A third consideration is that although money in the bank is referred to as a risk-free asset, recent events have shown there is still the risk of capital loss in the form of default by the issuer (bank or government). So what can investors do in this low interest rate and low inflation environment to give their portfolios a reasonable chance to enjoy real returns? NFB focuses on long term sustainable investing and it is with this in mind that the balance of this article continues.
The chart above more clearly indicates the volatility of the various asset classes. We can see that over the last 8 years listed property or equities have outperformed CPI and cash 63% of the time. The merits of being in these perceived riskier assets is evident, but what is the risk versus return trade off? The following scatter plot taken over the last 10 years illustrates the risk and reward profile of the four typically available asset classes as well as inflation linked bonds (another instrument to hedge against inflation).
What are growth assets? They are assets that display capital volatility and often provide a yield by way of a dividend or interest income. For my illustration I have not included offshore asset classes and so examples of assets further up the risk spectrum are bonds, listed property and shares. The graph below shows the investment profiles if you were to hold these riskier assets described above over the last 10 years. It is evident that an investor would have been rewarded for holding bonds, listed property and equities as they have cumulatively and substantially outperformed cash represented by the green line.
Source: Morningstar
Source: I-Net Bridge The previous graph illustrated cumulative returns so let us now look at the year on year returns and include inflation for benchmarking purposes.
Source: I-Net Bridge
Cash is shown as the blue dot; the All Share Index is the blue triangle and the Listed Property Index as the red triangle. The All Bond Index has been included as well as inflation linked bonds (green square). Inflation linked bonds have been included as they give an indication of the risk versus return profile of inflation. They typically trade at a premium above inflation. Once again we can see that listed property and equities have significant volatility (risk is shown on the x axis and returns on the y axis) when compared to cash, but over the long term have rewarded investors with inflation beating returns. The main concern an investor has investing in these growth assets is the possibility of capital loss, however, this can be mitigated through active management of the various asset classes and within the different asset classes themselves. A unit trust manager has various different instruments that he or she can invest in for example; in an equity fund the manager can rotate between financials, resources and industrials; and in a bond fund the manager can choose between corporate bonds, sovereign debt or inflation linked bonds. The combination of the various asset classes should match ones time horizon and risk profile and it is essential that you speak to your financial advisor to ensure your asset allocation is tailored to your specific investment needs.
Estate Duty What is estate duty and some pointers on how to reduce this liability. By Julie McDonald, NFB East London, Paraplanner
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ne thing most of us don't look forward to doing is planning for the inevitability of our death, but it is one of those things we all have to do, and should be part of our overall financial planning. We would start by making sure we have our Will in order, and making sure we have enough provisions by way of investment or life cover in order to care for our families and to pay off our debts. However, something that is often overlooked is making provision for estate duty or planning to minimize any estate duty.
What is Estate Duty? Estate duty is a tax levied in terms of the Estate Duty Act and it is collected by the Commissioner of the South African Revenue Service in respect of the estate of every person that has died or dies on or after 1 April 1955. Estate duty of 20% is currently levied on the estates of deceased persons in South Africa.
What is included in the Estate of a Deceased Person? ! All “property” of the deceased at the time of death. “Property” is defined as any right in or to property, moveable or immovable, corporeal or incorporeal. “Property” would include your residential property, holiday home, investments, cash, vehicles, jewellery and the like. ! All “deemed property” of the deceased at the time of death. “Deemed property” of the deceased includes policies e.g. Life policies, Buy and Sell policies. Once all that needs to be included in the estate has been finalised, there are certain deductions that are allowed:
Deductions from Estate Duty include, but are not limited to the following: Funeral and Deathbed expenses Debts due by the deceased Admin expenses Foreign Property (if acquired by the deceased before becoming an ordinary resident in RSA or if acquired by way of donation or inheritance from a non-resident) ! Limited interests reverting to a donor such as a fiduciary, usufructary, annuity charged upon property or any other like interest in property ! Bequests to public benefit organisations (e.g. SPCA) ! Claim in terms of the Matrimonial Property Act ! Polices, bequests or anything that accrues to a surviving spouse (section 4q) The Section 4A Abatement, currently at R3 500 000, is applicable to all estates. Once your net estate has been calculated, the abatement of R3 500 000 will be subtracted leaving you with your dutiable estate. Therefore, if you have a dutiable
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! ! ! !
estate of less than R3 500 000 no estate duty is payable. The estate duty rate of 20% is then applied to the Dutiable Estate to work out the estate duty payable by the deceased estate. Something to remember: if you are married in community of property, one-half of the joint estate forms property in the estate of the deceased.
What can I do to reduce my estate duty liability? One way to reduce your estate duty liability is by specifically bequeathing certain property to your spouse (including the residue of your estate). Donations between spouses are not taxable and everything left to your spouse will qualify for the section 4q deduction in terms of estate duty. Any 'deemed property' - life policies, with your spouse as the beneficiary, will also qualify for the section 4q deduction. You could also make use of a trust to achieve estate 'freezing', where growth assets are transferred to the trust. The costs and tax involved in this option need to be discussed with your wealth manager. Another great way to reduce your estate duty liability is by way of a single premium retirement fund contribution. To keep in mind is that all retirement products (RA's, pension funds, provident funds) are not estate dutiable, therefore you could transfer funds into a retirement annuity, where beneficiaries can be nominated (unlike a unit trust or share portfolio) and no CGT would be applicable. However, if needed, these funds would not be accessible to you until after age 55 and then only a maximum of 1/3rd can be taken in cash. On death, these funds will not be estate dutiable. There are also many other issues that need to be considered so it is best to discuss your specific circumstances with your private wealth manager.
Basic Example of Estate Duty Calculation: John died. The net value of his estate is R9 million. He leaves a legacy of R4 million to his son, Mark, and the residue of his estate is bequeathed to his surviving spouse. The residue (ignoring estate duty) is thus R5 million. Net value of estate Less Section 4(q) – Residue Net Estate Less: Section 4 A Abatement Dutiable Estate Estate Duty Payable (20%)
R9 000 000 (R5 000 000) R4 000 000 (R3 500 000) R500 000 R100 000
Note: The actual amount that the surviving spouse will inherit will be the balance of the residue after payment of the estate duty, this will come to an amount of R4 900 000 (R5 000 000 – R100 000).
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