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FirstQuarter
Newsletter 2012
unit trusts | offshore | retirement funds
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Features Dear valued investor
3
Focus and ownership key to investment success
4
Luck be a fickle lady
6
Are people paying too much for safety?
7
Wealth preservation - beating the evils of inflation
8
When headlines strike
9
Nomination of beneficiaries on living annuities
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The end of the world or the beginning of an era
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Our investment approach We help you find Best of BreedTM fund managers and the right investment solution When you invest, you want the most appropriate fund manager to look after your savings. We assist you in this process by actively researching and appointing fund managers to manage our fund range. Our independence is our strength Our fund manager research process helps us to identify managers with specific traits that we believe will enable them to deliver superior results over the long term. We focus on monitoring fund managers so that you don't have to Things do change. To help you manage this, and to ensure that our range remains Best of BreedTM, we actively monitor and review the appointed fund managers. If we think it is necessary, we will replace specific fund managers that are no longer deemed appropriate.
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Dear valued investor Our most important objective is to help our investors meet their investment goals. While there are different components to achieving this, one of our primary responsibilities is to ensure that the funds we manage perform well over the long-term. Over the past five years the returns from local equities (+8.1% p.a.), local bonds (+8.6% p.a.) and local cash (+8.8% p.a.) are not only all similar in magnitude, but are also barely ahead of inflation (+6.9% p.a.). This highlights that it has been quite a tough five years for investors looking for inflation-beating returns, especially once the punitive impact of fees and taxes are taken into account. Given current valuations of the equity market and that real (i.e. after-inflation) yields on fixed income investments are either negative or close to zero around the globe, it is likely to remain a challenging environment in which to generate inflation-beating returns.
Nic Andrew
Head of Nedgroup Investments
Overall, our range did well during a volatile and difficult year in which the local equity market was only marginally higher (+2.6%). Global markets fared even worse, with developed markets down 5.0% and emerging markets down 18.2% (both in dollars) for the year. There was a large depreciation of the Rand over the year, which started out at 6.62 to the dollar and ended at 8.06; a 22% drop. We continued to experience strong growth, with assets under management increasing to over R50 billion during the past year. Commentary on the performance of our large funds (as well as any fund enhancements) worth noting includes: The Nedgroup Investments Rainmaker Fund (+5.8% in 2011), our largest equity fund, had another solid year, finishing in the top quartile. It is also top quartile over three, five and seven years and places 2/34 over ten years in the general equity category. Over ten years, out of 45 general equity, growth & value funds, our three active funds place as follows: Nedgroup Investments Value Fund (2/45), Nedgroup Investments Rainmaker Fund (6/45), Nedgroup Investments Growth Fund (15/45). During December we merged the Nedgroup Investments Equity Fund into the Nedgroup Investments Rainmaker Fund, which helped reduce some complexity in domestic equity range. The Nedgroup Investments Global Equity Feeder Fund (+20.5% in 2011) had a fantastic year, placing 2/24. The Fund ranks 5/23 over 3 years, 9/18 over 5 years, 10/17 over 7 years and 3/15 over its maiden ten-year reading. The Nedgroup Investments Managed Fund (+8.3% in 2011) had a great year, finishing 7/70 in its category. Relative to all prudential medium & variable equity funds, the Fund ranks 14/86 over three years, 7/61 over ten years and 9/35 over seven years. We appointed Abax Investments to manage the Nedgroup Investments Balanced Fund in the second half of the year. There has thus far been a notable improvement in performance (although it is still very early days), with the Fund placing 8/73 in its first six months under Omri Thomas. The Nedgroup Investments Stable Fund (+11.1% in 2011) had another excellent year, repeating the success of 2008, 2009 and 2010. The Fund is 2/62 over one year, 2/56 over two years and 2/54 over three years. The Nedgroup Investments Positive Return Fund (+3.4% in 2011) had a disappointing year. The protected equity exposure has struggled in a volatile environment in which the market has essentially been flat and protection expensive. Over the longer term the Fund places 30/42 over three years and 9/34 over five years. The Nedgroup Investments Flexible Income Fund (+12.1% in 2011) had a superb 2011 after a poor 2010. The offshore allocation paid off in a year when the rand fell by over 20%. The Fund now ranks 1/52 over one year, 19/49 over three years, 12/44 over five years and 5/38 over seven years. Nedgroup Investments recently placed second overall in the “Domestic Management Company of the Year” category of the annual Raging Bull awards. The award takes cognisance of our entire domestic unit trust range (with a few small exceptions) and measures it on risk-adjusted returns over three and five years. It is therefore a reasonable reflection of the results that our range has delivered for investors. We are very proud of the award and particularly that this is the third year in a row that we have been placed in the top three companies in the industry. Thank you very much for your support. All the best for 2012 and good, sensible investing! Regards,
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Focus and ownership key to investment success
Matthew de Wet
Head of Investments
A recent article in the Financial Analysts Journal entitled: “Most Likely to Succeed: Leadership in the Fund Industry1” makes some interesting points about the evolution of the fund management industry and the structure of successful investment firms in the US. We believe that many parallels can be drawn to the South African fund industry. The authors suggest that the best predictor of success for a fund management business is predicated on two critical factors; namely, focus and ownership structure. In other words, those firms that focus exclusively on fund management (as opposed to financial conglomerates that supply a diverse range of financial services to their clients) and that are owned by the investment professionals themselves are most likely to succeed. They note that the market share of dedicated fund management firms (those that derive the majority of their revenues from fund management) has grown substantially over the past two decades. In the US, the market share of such firms rose from 40% in 1990 to 55% in 2010. Our analysis of the South African unit trust industry paints an even more dramatic picture, with dedicated fund management firms increasing their market share2 from 25% to over 40% in just ten years. Apart from increased market share, it seems that dedicated fund management firms have also produced superior results for their investors over time. In a speech to the Boston Security Analysts Society in 2006, John Bogle, founder of the Vanguard Group cites evidence of this. The research, which covers a ten-year period, rates over 50 of the largest US-based fund firms across their entire fund range and gives each of them a percentile ranking for their range as a whole (i.e. a score of 40% implies that the fund range for that particular business was on average in the top 40% of funds when compared to all other funds with similar objectives). The results are highlighted in the table below:
# Firms
Percentile ranking of fund range
Dedicated fund firms
20
33%
Financial conglomerates
34
55%
Total
54
47%
US fund market
Source: Vanguard
Overall, dedicated fund firms produced results for investors that placed them in the top third, whereas firms that were part of financial conglomerates had results in the bottom half. Furthermore, of the top ten performing firms, only one was classified as part of a conglomerate and of the bottom ten performing firms, only one was not a conglomerate.
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Robert Pozen and Theresa Hamacher, November/December 2011. Volume 67, number 6. Financial Analysts Journal Excludes money market funds as these are dominated by the fund firms linked to banks
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Analysis of the South African market yields similar results. The PlexCrown Survey, which rates fund management houses on a risk-adjusted basis, highlights that dedicated fund firms have also performed better in the SA market. The table below indicates that the average score (for each quarterly survey over the past five years) was 3.8/5 for dedicated fund firms and 3.0/5 for financial conglomerates (the higher the score the better). In addition to this, only one of the top five companies was part of a financial conglomerate, and this company outsources the asset management function to (predominately) dedicated fund firms. In other words no firm that was part of financial conglomerate produced better results than a dedicated fund firm (or a hybrid thereof) over the period of analysis.
# Firms
Average PlexCrown score
Dedicated fund firms
4
3.8
Financial conglomerates
8
3.0
Total
12
3.2
SA Fund market
Source: PlexCrown Survey and Nedgroup Investments. Mar 07 -Dec 11 quarterly surveys
We believe that the most important reasons for the loss of market share and poor relative performance of financial conglomerates are as follows: 1. Diversified firms have had trouble retaining key investment management professionals as these individuals tend to prefer a smaller company environment and a flat structure. Large, diversified firms with their many layers of management and corporate bureaucracy struggle to provide such a working environment. Furthermore, the incentive structures are not properly aligned; key employees of diversified firms are more than likely awarded an annual or bi-annual bonus which can lead to short-term investment decision making in order to maximise current income. Also, the performance of shares or options awarded in the diversified firm is linked to the performance of the overall business and not the fund management division itself, again creating potential misalignment. The importance of manager tenure and manager alignment of interest (via ownership) should not be underestimated. Recent Morningstar research, which compares the Morningstar Star rating a proprietary indicator of fund manager skill and success to a fund manager s investment in the funds they manage and their average tenure at the firm they work for. The research clearly indicates that there exists a strong relationship between manager tenure, manager performance and a manager s investment in the funds that they manage. Average investment in fund
Average tenure (years)
Star performance rating
$300,000
6.2
5
$251,000
6.3
4
$162,000
5.4
3
$125,000
4.6
2
$111,000
3.8
1
Source: Morningstar Principia. 5 years to Jan 2010
2. Many large diversified financial firms are listed entities and need to report results frequently to shareholders. This makes them ill-equipped to deal with the vagaries of investment performance, as shareholders (who do not necessarily understand that an investment process that is likely to deliver good results over a full market cycle almost by definition will deliver poor results in some years) are likely to exert pressure and agitate for change if the firm is going through an inevitable poor patch . Businesses that are owned by the fund managers better understand the long-term performance imperative and are less likely to make decisions that may help alleviate short-term underperformance pressures at the expense of long-term results. 3. Finally, and particularly in the South African market, we believe there is a distinct advantage in not being too big (or too small, as a certain level of assets is required given the resource requirements of fund management). The reason size can be a hindrance stems from the concentration of our stock market. Simply put, the larger you are, the smaller your investment universe; and all things being equal - the smaller your investment universe, the lower your probability of outperforming. Investors may be well served by identifying those managers that are structurally well positioned to deliver on performance objectives over the long term. Such firms are likely to be focused on fund management alone, are likely to be owned by the fund managers themselves and should not be too big and bulky.
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Excluding companies that did not have a reading for at least ten of the 20 quarters
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Luck be a fickle lady
Madelet Sessions Investment Analyst
In his book Outliers The Story of Success , Malcolm Gladwell explains the role luck plays in outcomes. Idiosyncrasies, like when you were born, what school you attended, or the cut-off date for joining a team can influence the outcomes dramatically. Gladwell writes that some of the world s most successful entrepreneurs John Rockefeller, Andrew Carnegie and JP Morgan - had been born within a few years of each other in the 1830s and benefitted from the industrialisation of America. More recently successful entrepreneurs - Bill Gates, Steve Jobs and Paul Allen - were all born within a couple years of each other in the mid-1950s and participated, and contributed to the technology boom. Gladwell concludes that having the right skills (10,000 hours of practice) is an important pre-condition for success, but having those skills at the right time can mean the difference between a good outcome (a steady job and good income) and a fabulous one (being one the wealthiest people to have ever lived). Luck vs skill Just as individual successes are influenced by luck, so too are the outcomes of decisions made by investment managers, and the businesses in which they invest. For a business executive, a good decision or strategy can be thwarted by an unexpected and unpredictable event. What might have been a good decision with the information available at the time turns out to be a terrible decision with hindsight. Consider the Japanese business executive that spotted a great opportunity and committed capital just before the horrific and unpredictable tsunami hit. Whatever losses the business suffered as a result cannot be wholly blamed on the executive. The outcome was the result of good skill and bad luck. The business executive at a competing firm that did not spot the opportunity, did not risk any capital, and consequently did not suffer losses benefitted from the combination of bad skill and good luck. News flow can influence markets and asset values in a variety of ways and is generally unpredictable. On any given day news can be good or bad, and better or worse than expected. This news, if better than expected will drive asset values higher, and if worse than expected will cause asset values to decline. One should think of this influence on portfolio values as the influence of luck. Fortunately, (from Fortuna, the Roman goddess of luck) luck is fickle. In statistical terms the contribution of luck has an expected value of zero. And, as we all know, but is sung so delightfully by Frank Sinatra in Luck be a Lady, luck has an un-lady-like way of running out . Statistically speaking, the effect then, of luck, should be transitory and over the long run outcomes should be determined by skill. 6
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Consistent skill will outperform luck A skilled investment manager has the ability to distinguish between business fundamentals and market expectations. Fundamental analysis includes identifying skilled business executives, macroeconomic trends and business opportunities and how much of this is reflected in the price of the security. Having identified opportunities a skilled manager allocates capital according to the attractiveness of the opportunity and the quality of the idea. By applying this skill with discipline and consistency, skilled investment managers display a greater tendency for outperformance as luck on its own (being fickle) is not sufficient to offset the influence of skill and sway the results. And sometimes, the stars align and extraordinary good luck and great skill combine to result in long streaks of outperformance. Michael J. Mauboussin, from Legg Mason Capital Management, suggests that the longest streaks should be held by the most skilful participants. Stephen Jay Gould, a biologist and sports enthusiast famously summarised long streaks are, and must be, a matter of extraordinary luck imposed on great skill. Although streaks occur, they are rare. As such, it is worth remembering that a run of truly exceptional performance by a skilled manager (be it exceptionally good or bad) is unlikely to persist. Outsmarting the crowd As more and more skilled managers join the markets, the more difficult it will become to generate exceptional performance. This is known as the paradox of skill. To deliver exceptional returns, one needs to be smarter than the crowd. And if the crowd is getting smarter, generating exceptional returns become ever more difficult. As a result, most investors will earn market returns. To do better, you will need to invest with skilled investment managers (that maintain their advantage relative to the market) and stick with these managers through periods of unlucky underperformance. You will also need to resist the temptation of investing with unskilled managers currently benefiting from a lucky streak. This ought to help stack the odds (for exceptional long-run returns) in one s favour.
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Are people paying too much for safety? Andy Headley
Veritas Asset Management Portfolio Manager of the Nedgroup Investments Global Equity Fund
There is something about the dawn of a new year that encourages otherwise sensible people to make predictions about the year ahead. In the investment industry predictions are given for the level of stock markets, interest rates, GDP growth rates and foreign exchange rates to name a few. The historic inability to predict any of these factors with any consistent degree of accuracy does not dissuade these seers from trying each year. Looking back at some of the predictions made last year, the most noticeable and frequent predictions were for a continuation of the recovery that most economies were then enjoying. Consequently most of the prognosticators expected 2011 to be a year of recovery with growth accelerating through the year leading to an especially robust final quarter. Having re-read a number of these forecasts from January 2011, I have not found one that predicted the severity of the Euro crisis, the Arab Spring or that the US would see its credit rating downgraded. Do not be surprised by the lack of success Human psychology involves heuristics these are basically short cuts that the brain uses to process information in an efficient way to prevent us from suffering information overload (though many of us may feel we suffer this despite heuristics). However these short cuts often prevent us from correctly processing and interpreting information. Two particular traits encourage us to make (and believe) erroneous forecasts. These traits are known as anchoring and overconfidence (perhaps particularly common in financial markets). Anchoring is the tendency of individuals to stay close to a piece of factual information whether relevant or not. For example forecasts for the S&P 500 index for the end of 2012 are typically based off the current level so there is anchoring around the current level in forecasts. As a result, forecasters are very good at telling you what has just happened. Overconfidence should need no explanation but put simply is the situation where people are surprised more often than they expect to be. Unfortunately experts tend to be most prone to overconfidence as the illusion of knowledge encourages it. Studies have demonstrated that armed with more information, experts are far more likely to make erroneous predictions and also have more confidence in their predictions than laypeople. So, why bother? Instead of making worthless predictions, time would be better spent by considering the present situation and what that implies for the future, what events could occur, how likely such events are and what the implications are for investment of each possible outcome. Furthermore, this should be a continual process looking
out over a suitable timeframe which in most cases is not an arbitrary 365 days (or 366 in 2012). Such an analysis should then operate in conjunction with a consideration of what to do about the opportunities and risks identified (Buy? Hedge? Sell?). For investors, this final part involves focusing on individual companies and then analysing and valuing these companies. Finding and keeping the balance At Veritas we continually consider the environment in which we are investing and express this through our use of themes. These are adaptive and so are amended or change when relevant. These themes are then used to both identify potential investments for further analysis that will benefit from the environment we envisage and also to help us skew the portfolio to such beneficiaries (when available at attractive valuations). Our themes help us to deal with the likely environment we envisage and also help us assess some of the risks and identify companies that are protected against these. While the current economic malaise affecting developed economies has been beneficial for our dependable compounders theme, it is becoming increasingly difficult to find such companies at attractive valuations. The past two years uncertainty has led many investors to want the dependability offered by these companies and consequently valuations now reflect that. While we still own a number of these dependable compounders that we believe will deliver attractive returns over our investment horizon, there are few we would buy more of today. In fact in the three months to the end of 2011, we sold our sizeable position in US pharmaceutical company Merck on valuation grounds following strong share price performance. As a consequence, we are now working to identify and analyse more economically sensitive companies that we consider to be industry leaders in their respective areas. As other investors have sought defensive companies over the past year (benefiting many of our holdings) some of the more cyclical areas have been ignored leading to some quality cyclicals now appearing to offer the prospect of attractive returns over our investment horizon. We are currently in the process of analysing these in more detail but believe that holding some more economically sensitive positions would help hedge the portfolio in the event of a reflationary cycle taking hold. Given the possibility of this outcome combined with the dangers of being too concentrated on one side of the boat we believe a more balanced portfolio at this juncture is appropriate and are working to this aim.
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Wealth preservation - beating the evils of inflation William Fraser
Foord Asset Management Portfolio Manager of the Nedgroup Investments Stable Fund
Inflation is currently above the upper band of the SA Reserve Banks 3 6% inflation target range. The MPC, in their recent statements, reconfirmed their belief that the rise in consumer prices is unrelated to general economic conditions. Focusing on credit extension and core inflation , they believe demand driven inflation remains largely absent in the SA economy. For this reason, despite the MPC s view for inflation to stay close to the 6% upper limit for some time, interest rates are projected to stay little changed. Therefore, the preservation of capital in real terms must form the core of investment philosophies if one wants to beat the evils of inflation. Investors must select investments that have the ability to grow their values over time. Such growth comes through increases in the price of the investment (capital growth) and through increases in annual income payments (dividends or interest). This is particularly true in the present environment, where nominal interest rates are very low, both domestically as well as globally, and interest rates are falling in real terms because rising inflation is not immediately offset by rising interest rates. Interest yields are generally insufficient to cover the risk that inflation will be higher than the market expects. So, one must seek alternatives to investments in the cash and traditional bond markets. Investors must search for assets on high yields, where the payments are highly predictable, capital is safe and importantly, incomes can grow over time. Investments that meet these requirements are often not in traditional interest bearing instruments like the cash and bond markets which are often overlooked as options to grow income and capital. Inflation beating options Listed property instruments have typically delivered returns well above inflation. In the early part of the millennium, yields were attractive and price appreciation accounted for a large portion of the total real returns achieved over the last decade. Despite much lower yields compared to ten years ago, the fundamental approach to listed property as an asset class has not changed. The addition to portfolios of good quality listed property companies with attractive yields increases the probability of producing inflation beating returns. Annual escalations in rentals of around 8-9% per annum are still being achieved in this sector and over time, this growth in rental income should provide for growth in distributions to investors that are above inflation. However, the current low yield in this sector doesn t provide investors with a fantastic entry point into the asset class, and a bit of patience is required. In the current low interest rate environment, cash-flush companies are able to return a significant amount of earnings to shareholders. Looking forward 12 to 18 months, dividend yields should approach cash rates in many cases. Importantly, dividends are real, while cash yields are nominal. Investing in companies that can pass on rising input costs to their customers is important especially in a rising inflation environment. Equally important, is to trust the management teams of companies to deal with issues like rising prices. Investors should generally seek to support management teams which have dealt successfully with previous episodes of rising inflation. Dividends are an important component of total investment returns. Investing in companies where dividends grow over time provides additional certainty in maintaining one s standard of living. Growing income from investments is an important component in the wealth creation process. It provides a more certain investment outcome than bonds or cash, where one assumes significant inflation risk. Listed property with growing distributions and shares with growing dividends are critical to the success of achieving returns which beat inflation. This is particularly true in times when the outlook for inflation is negative and mispriced.
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When headlines strike
Matthew de Wet Head of Investments
Peruse any financial publication and you are likely to find some heart-stopping headlines. This is because headlines sell newspapers. The headline of the article below reads: Global equities sink as uncertainty in Italy inflames fears and is enough to strike fear into even the most hardened investor. Then study the actual content that describes how the Dow Jones Industrial average dipped by 0.27% in mid-morning trading and that the Top 40 Index finished 2.19% higher . Hardly newsworthy and hardly negative, but only careful reading exposes this.
Given that there are currently many reasons to be negative about the state of the global economy, it is no wonder that most headlines are so negative. Investors from the developed markets, particularly Europe where the news is the worst, have all but abandoned equities in favour of perceived lower risk asset classes such as cash and government bonds.
The reality is that although global growth may be slower, corporate profitability and equity returns may not necessarily be lower over a reasonable investment horizon of five to seven years. Consider China as the poster child in this regard. The country has experienced one of the greatest economic booms in history over the past 15 years, with GDP growth clocking in at a mouth-watering 10.4% per annum, compared to the poor old US with its rather lacklustre 2.6% per year. Yet, with all that economic growth, company earnings growth has actually been marginally negative, while in the US it is been a healthy 5.4% per year. Similarly, Chinese equity market returns have been -2.3% per annum compared to the +6.1% per year in the US. This is certainly not a result that many would have expected and surely most of us, if offered the opportunity to invest in an economy growing at 10% per annum, would chose to do so over an economy growing at less than 3%.
GDP Growth and Equity Performance: China vs. US
Chinese equity returns have been lower and more volatile than those of the US despite better growth
40% 35%
US China
37.1%
30% 25% 20% 15% 10% 5%
15.3% 10.4% 6.1% 2.6%
0% -5%
GDP Growth*
-2.3% Equity Market Return
5.4% -0.9% EPS Growth**
Volatility
Source: Goldman Sachs, 1995-2010
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So why the discrepancy between economic growth, corporate profitability and stock market returns? The primary reason is that of valuation. When the outlook is rosy, investors are generally prepared to pay much more for their investments than they are when the outlook is dire. The consequence of this is that they tend to overpay in good times so much so that even if the good times continue, returns can be poor because the price you paid was too high. Investors also tend to shy away when prices are low and offer healthy prospective returns, because the outlook is often dire at that point. The lesson here is that valuation (not news flow or economic growth) is the most important driver of investment returns over a full market cycle. The importance of valuation is highlighted in the chart below, which analyses the returns of the South African stock market compared to the valuation of the market (from 1960-2011). The chart plots the relationship between starting valuation (as described by the price earnings multiple of the market - a number which is known at the time of investment) and the subsequent seven-year annualised return of the market. Each grey dot represents a data point and the salient points to glean from the chart include the following:
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40% 35% 30%
7 year return pa
There is a noticeable pattern between starting valuation and subsequent return; the higher the starting valuation, the lower on average - the subsequent return. In fact, the so-called fit between the two variables is quite high at 64%. Statistically this implies that 64% of the sevenyear market return has historically been attributed to the starting valuation. In other words valuation is a useful starting point for making investment decisions. There is clearly a fairly wide range around the best fit (diagonal) line, which implies that valuation is not a perfect predictor of returns, but rather a useful starting point when thinking about prospective return. The long-term average reading is represented by the blue square (which falls on the best fit line). In other words, the average PE of the market from 1960-2011 has been 11.5 times the earnings and the average annualised return has been 18%. Given that inflation has averaged 10% per year, the market has delivered 8% real growth over the past 50-odd years. The current multiple of the market (red circle) is around 13 times earnings. Note that because profit margins are currently at somewhat elevated levels it may be prudent to compensate for this by adjusting the multiple upward a little (let s say 14 or 15 times earnings marked by the green triangle). All of this implies that a simplistic expectation for equity returns over the next seven years should perhaps be in the region of 3-4% per annum less than the historical real return of inflation at + 8%. This would leave investors with returns in the region of 4-5% above inflation over the next seven years.
25% 20% 15% 10% 5% 0% -5% -10% 0%
5%
10%
15%
20%
25%
30%
Valuation (PE) Source: Nedgroup Investments, data from 1960-2011
Amid all the fear and uncertainty across the globe, equities are unfortunately not screamingly cheap by any standard, but they do offer the prospect of reasonable rather than exciting returns above inflation along with a potentially bumpy ride. Equities would need to be cheaper still in order to provide sufficient upside to go all-in . That said, the alternatives may well be worse with real bond yields close to zero (or even negative) in most countries and cash yields at historic lows; both offering little protection from current inflation - and potentially higher inflation down the road.
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Nomination of beneficiaries on living annuities Liezel Momberg Head of Legal Services
Compulsory annuities must provide a pension On retirement from a retirement fund 1 a member may commute up to one third of their retirement benefit as a cash lump sum and the remaining balance must be used to provide an annuity (pension) via a compulsory annuity . The compulsory annuity can be provided by the retirement fund (fund provided); or it can be purchased from an insurer in the name of the retirement fund (fund owned) or in the name of the member (member owned). There are different types of compulsory annuities. Some guarantee the annuity until death of the annuitant, but do not provide for the payment of a remaining asset value to nominees on death of the annuitant. Others do not guarantee the annuity, but provide for the payment of the remaining asset value to nominees or the estate on death of the annuitant.
contractual terms provide that where the nominee is not a natural person or is a trustee of a trust, only a lump sum will be paid on his death i.e. only nominees who are natural persons will have the option of a lump sum and/or an annuity. His first wife has died and he has two adult children from that marriage. He has remarried. He does not have any children with his second wife, but she has two adult children from her first marriage. His living annuity makes up most of his wealth. He wants to make sure that his second wife is provided for until her death, but he wants his two children to benefit from any remaining value on his second wife s death.
Nomination of a beneficiary The nomination of a beneficiary (nominee) on a member owned living annuity is subject to the contractual terms of the insurer4 as set out in the annuity policy. Many living annuity policy contractual terms do not prohibit the nomination of a nominee who is not a natural person or the trustee of a trust. However, the contractual terms often provide that where the nominee is a trustee of a trust or is not a natural person, only a lump sum will be paid to the nominee on death of the annuitant i.e. the annuity option will not be available to the nominee.
The following are some of the options to consider: Make assumptions of the capital required to meet his second wife s income needs and nominate her for a certain percentage as beneficiary and nominate his two children as the beneficiaries for the remaining percentage. His wife and children will each be able to decide whether they want to receive their benefit as an after tax lump sum or annuity or both. His estate is saved executor s fees and there are no estate duty implications. By doing this he accepts that his wife will be able to deal with whatever value remains on her death i.e. his children may not benefit. The risk is that he may not have provided sufficiently for his wife until her death. Set up a trust during his life time or in his will and nominate the trustee of that trust as the beneficiary on the living annuity. The trust will receive an after tax lump sum following his death and can pay his wife an income during her life time. On her death his two children can benefit from the remaining value. His estate is saved executor s fees and there are no estate duty implications. The cost of setting up and maintaining the trust may have to be considered. Make no beneficiary nomination and the remaining value on his death will be paid as an after tax lump sum to his estate. The executor will then deal with it in terms of his will and will be able to charge executor s fees. There is no estate duty implication.
Case study Mr X is the annuitant on a member owned living annuity. The policy will come to an end on his death and payment will be made to his nominees or estate as applicable. The policy
Conclusion Annuitants and their financial and estate planners must carefully consider the implications of beneficiary nominations on member-owned living annuity policies.
Living annuity A living annuity2 is a type of compulsory annuity and is defined in the Income Tax Act, 1962. The value of the annuity (pension) is determined solely by reference to the value of assets held and the amount of the annuity is not guaranteed. On death of the annuitant, the value of the remaining assets may be paid to the nominee of the annuitant as an annuity or lump sum or as a combination of both3 or in the absence of a nominee, to the annuitant s estate as a lump sum.
Pension fund, pension preservation fund, retirement annuity fund. Members of provident funds or provident preservation funds do not have the same limitations, but the rules of many of these funds provide for a compulsory annuity, all or part of which may be commuted for a lump sum. 2 Also referred to as investment-linked life annuities (ILLA), flexible annuities, linked annuities 3 As amended by the Taxation Laws Amendment Act 24 of 2011, effective 1 March 2012 4 Fund provided or fund owned compulsory annuities may have different provisions that apply to the nomination of beneficiaries 1
Please note that while care has been taken to ensure that the information provided in this communication is correct, it represents an overview of the topic under discussion and is offered for general informational and educational purposes. It is not offered as and does not constitute legal nor investment advice.
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The end of the world or the beginning of an era Aubrey Matshiqi
Political Analyst
If prophesies about 2012 being the year in which the lights will finally go out for humanity are true; what is contained in this article will not matter. In case the prophets, false and otherwise, are wrong, 2012 is going to be one of the most exciting or frightening years, depending on one s vantage point, in South Africa s political history since 1994. Celebrating one hundred years of existence The year kicked off with the African National Congress (ANC) cutting and eating cake in celebration of one hundred years of its existence. While the ANC has a lot to celebrate, its leaders and rank and file membership, also have a lot to worry about given the fact that in December the ruling party will be going back to Mangaung, Bloemfontein, not only to conclude its centenary celebrations, but also to hold its national conference. The conference, the highest decision making body, will excite the popular imagination because it is there that branch delegates will either re-elect or unseat President Jacob Zuma. It is also at this conference that the policies that will be adopted at the party s National Policy Conference in June 2012 will either be endorsed or rejected. This means that at this conference a resolution calling for the nationalisation of mines will either be adopted or rejected. The struggle between Zuma and Malema The decision of the National Disciplinary Committee of the ANC to suspend the ANC Youth League s president membership for five years constitutes the beginning of the end for him or his nemesis, President Jacob Zuma. However, all of this will depend on the evolution and shifts in the balance of forces and support in the months leading up to the Mangaung conference of the ANC. According to the constitution of the ANC, the five-year suspension that was imposed on Julius Malema cannot kick in until he has exhausted all internal remedies. If he loses on appeal - and I think he will, except for the possibility of a reduction of sentence he will try to put the matter on the agenda of the National Executive Committee (NEC) of the ANC which is the highest decision making body between national conferences. At this point, the disciplinary matter will assume a purely political dimension. The NEC will have two options; either refuse to discuss the matter or allow Malema and his supporters to put their case before it. If it refuses, that will be the end of the road for Malema. If it decides to hear the matter, what will follow is a test of levels of support for Zuma and Malema in the leadership of the party. If Malema has miscalculated the balance of support, not only will he find himself in the political wilderness much sooner than he desires but will also find it difficult to mobilise support for his policy and leadership preferences. If, on the other hand, the balance of support tilts in his favour, Zuma is in trouble. But things can go terribly wrong for Malema given the fact that the disciplinary process is but one part of a complex and multi-dimensional political battle that is being fought on many fronts.
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Whose race is it anyway? But, we must not think that the future of the ANC and Zuma depends either exclusively or mainly on what will happen in the battle between Zuma and Malema. We must remember that not everyone who likes Malema hates Zuma, and not everyone who wants Zuma removed loves Malema. The president may benefit from two factors. First, there is no doubt that Malema is plagued by what seems to be a growing image crisis for him in the leadership of the ANC. Second, those who want Zuma out still do not have a candidate. If the hope that Kgalema Motlanthe will enter the leadership race is dashed, Zuma will be re-elected even if it is by default. However, the disadvantage for Zuma lies in the possibility of being elected by an ANC that continues to be divided and unstable. If he wins the election when many desired an alternative, his second term may be more difficult than the first. The power of external forces In July and September of this year, the South African Communist Party (SACP) and the Congress of South African Trade Unions (Cosatu) respectively, will be holding their elective congresses. The period leading up to each congress will see the publication of policy discussion documents that will be aimed at influencing the content of policy debates in the ANC. In addition, the results of these congresses will, in part, determine the outcome of policy and leadership battles in the ANC. The future of economic policy? I have no reason to believe that the ANC will adopt nationalisation as one of the key pillars of its economic policy. The nationalisation debate is not about nationalisation at all. It is about the extent to which the state must be involved in the economy. The ANC will most probably restate its commitment to a mixed economy and the idea of a democratic, developmental and interventionist state. If the ANC adopts nationalisation, I will eat both my hat and head! But we must not be complacent because the failure to tackle poverty, unemployment and inequality may undermine political, social and economic stability in South Africa given the fact that the youth are becoming increasingly angry and frustrated about their poor socio-economic conditions. Also, we should be concerned about the possibility of a rating downgrade by key ratings agencies and the impact thereof if political and policy uncertainty persists for the better part of 2012. One of the things we need is a clear definition of the three spaces in which the private sector and the state must operate in the economic interests of our country. The first space must be where the private sector does what it does best, that is, creating goods, services and jobs in its role as a key driver of economic growth. The second relates to the enhancement of state capacity, and the third is about co-operation between the state and the private sector. This requires the creation of public/private sector dialogue platforms from which a shared understanding of the challenges, opportunities and risks will hopefully emerge.
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unit trusts | offshore | retirement funds
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