Your questions answered

ADVICE ON BUYING A LIVING ANNUITY

I am considering buying an investment-linked living annuity with a large portion of my retirement capital when I retire in six months. I have a few questions:

1. In investing for income, as well as growth, what is the recommended split between income-producing funds and the more risky growth funds?

2. Can I change these underlying investments at any time?

3. Fees on these annuities appear to be relatively high. Could you outline what fees I will pay and roughly how much they will be as an annual percentage of my investment? Is there any way to reduce them?

Name withheld

Graham Lovely, a financial adviser at PSG Wealth in Rondebosch, responds: When deciding on the split between income and growth assets, you must bear in mind that, in order to provide good growth, growth assets require more time to overcome the volatility in the returns. You must first determine your income and capital requirements and then consider factors such as your investment time horizon and risk profile.

We recommend that your income and capital requirements for the first three years in retirement are allocated between cash and income funds, in accordance with our view on the interest rate cycle. Normally, the allocation is entirely to cash investments, such as money market and enhanced cash funds. There is virtually no investment risk and the funds are 100-percent liquid.

The second and third years’ income and capital requirements would be allocated to income funds. These funds are invested in cash, bonds, listed property and other income-generating investments. There is a slight risk of volatility, and the target is to achieve higher returns than money market funds over a term of more than a year.

The income and capital requirements for the next three years (years four to six) would typically be allocated to funds with an equity allocation of between 30 and 40 percent. These funds usually target returns in excess of inflation plus three percent over a rolling three-year period. The risk of capital loss over a three-year term is nominal.

The balance of the investment may be allocated to long-term investments in balanced and equity funds. These funds may experience high volatility, and the target is to achieve returns higher than inflation plus four to seven percent over periods longer than six years.

You may change these underlying investments at any time. This is not always a good idea, because you don’t want to make investment decisions based on emotions, so rather plan your strategy upfront and then try to stick to it, within reason. You should rebalance your portfolio from time to time in line with your investment strategy.

In terms of fees, there are essentially three components: administration fees, asset management fees and advice fees.

All investment platforms offer similar services and provide clients with access to most of the unit trust funds available. These fees generally range between 0.228 and 0.525 percent (VAT included).

The asset management fee of a multi-manager, where a fund of funds is used, is typically 0.46 percent (VAT included). This, however, does not include the fees of the managers of the underlying funds.

The total expense ratios of the various funds can be found on the fund fact sheets. These vary considerably according to the nature of the fund, the asset manager and even the institution offering these funds on its platforms.

Ongoing advice fees of 0.75 to one percent plus VAT are the norm.

In order to reduce fees for a living annuity investment, obtain quotes from various investment platforms and compare the fee for administrative services. Then select one or two platforms and obtain comparative quotes that include all the categories of fees.

WHY IS LISTED PROPERTY IGNORED?

I read in Personal Finance (January 23, 2016) that listed property has out-performed all the other asset classes over the past 14 years. But whenever “experts” talk about investing, they harp on about equities, saying they’re the best way to earn inflation-beating returns. Why aren’t we told to invest most of our money in listed property when the returns have been so good?

Henry Beauvoisin

Braam Fouche, a financial adviser at PSG Wealth in Umhlanga, Durban, responds: Your question can be answered in part by the fact that, historically, property was simply ignored, because most asset managers did not consider property as a means of diversifying their portfolios. This approach has changed over the past decade, and property has become a recognised asset within portfolios.

Listed property has the same risk characteristics as equities. This is because you are not investing directly in property, but are buying the shares of companies that focus on property assets. Intrinsically, you are investing in equity and not property, which, like any other stock, can easily disappoint if your decisions are based on skewed fundamentals. The risk is also higher than normal, because you are exposing yourself to a single sector of the stock market, which may fall out of favour at any time.

Over the past 15 years, listed property was supported by global events that drove the value to where it is today. After the dot.com crash of 2001, disillusioned equity investors started shifting their focus to this “new” asset class. Few investors realise that the initial spark for this development was the fiscal intervention of the United States Federal Reserve in 2001, which aggressively dropped interest rates to curb the effects of the dot.com crash. This intervention created a global surge in property values and the wide-ranging demand that followed.

The demand led to new property company listings, the rise of real estate investment trusts and property unit trust funds, which increased the demand and drove prices even further.

The 2008 subprime crash is directly linked to the exuberance in property markets. Investors’ memories are short, because they don’t realise that similar or even more risk prevails now.

South African listed property investors were relatively unaffected by the subprime crisis because of good governance and the earnings growth created by the 2010 soccer World Cup.

Developed-market governments reacted to the 2008 crash with unrivalled fiscal intervention, marked by aggressive drops in interest rates that went far beyond the 2001 reaction, and emerging-market governments followed suit.

In this “new normal” world of low interest rates, investors started “searching for yield”, and additional capital poured into the bond and property markets. This surge drove the average price-to-earnings ratios of property stocks well above acceptable levels, while in South Africa the income yields on property dropped below those on bonds. This indicates risk, because bonds are generally a lower-risk asset class, and property yields should be higher to reward investors for the increased risk.

The experts are thus not “ignoring” listed property shares; they are treating them correctly as a specific sector of the broader market, while prudently focusing on the risk, backed by the adage that “past performance is not a guarantee of future returns”.

Currently, the main focus of most governments is to “normalise” their economies, which means raising interest rates. This is in contrast to the events described above and marks an end to “the easy money party” to which we have became accustomed.

In a struggling global economy and a South African economy plagued by a likely recession, property companies face the possibility of higher borrowing costs and a reduction in rental income. Continuous growth in the property sector is highly unlikely.

IS VOLATILITY GOOD OR BAD?

The term “volatility” comes up whenever people talk about shares and unit trusts. I believe it describes by how much a share goes up and down over a period of time. Is this correct? My other questions are:

1. How is volatility measured? Is there an index or something similar that shows the volatility of investments on the JSE? If so, where can I find it?

2. It seems that volatility is “just a fact of life” when you invest in shares, but is there such a thing as “too much” volatility? In other words, if the price of a share or unit trust is rising and falling rapidly over a short period, does this mean that something is wrong and I should disinvest?

MJ Lindeque

Wico Strydom, a financial adviser at PSG Wealth in Silverlakes, Pretoria, responds: Volatility refers to the up and down movements of a stock, index or asset class over time.

Volatility is measured by the size of the movement of the share price, index or asset class from its average price over time. This is called the standard deviation.

In South Africa, the SAVI Top 40 Index measures the volatility of the Top 40 shares. It can be found on the JSE’s website.

Healthy volatility is when volatility creates opportunities to buy good companies at lower prices. If the volatility of a share is caused by an inherent problem with the share, it may indicate that there is something fundamentally wrong with the company.