|In this newsletter:
Benchtest 10.2018, Government should lead by example, smoothing investments returns and more...
Important notes and reminders
The Payments Association of Namibia has announced that cheques will be phased out as a payment instrument by 30 June 2019.
If you overlooked the announcement, download it here...
FIM Bill – Are you ready to comply?
Marlene Miller Compliance Practitioners will be hosting a seminar on the FIM Bill at NIPAM, Paul Nash Street Olympia, on 29 November from 09h00 to 13h00. The objective of this seminar is to better your understanding of future regulatory requirements in preparation for compliance.
Download the advertisement here...
Inland Revenue Communique w.r.t. tax administration matters
ICAN representatives attended a meeting with the Directors and Regional Managers of Inland Revenue Department (IRD) on 13 September 2018 to discuss the ICAN letter that was sent to the Minister of Finance regarding tax administrative challenges most often encountered by taxpayers and tax practitioners.
During that meeting the IRD mentioned that they also experience problems with the returns and supporting documentation submitted by taxpayers/practitioners. The Communique to Tax Payers received from the IRD, outlining the most common problems experienced by the IRD, thereby contributing to the administrative challenges experienced by the IRD, taxpayers and tax practitioners. Find Inland Revenue communique here...
VET levy exempted organisations defined
Paragraph 4 of the notice issued under the VET Levy Act 2008 was replaced and the exemptions granted under paragraph 4 of the notice issued are now defined in a new Schedule C introduced by government notice 290 of 2 November 2018, published in government gazette 6760 of 5 November 2018. All organisations falling into any of the below categories are well advised to study the definitions in order to establish whether they may now be exempt or may no longer be exempt and may have to amend their constitution or have a constitution adopted in order to claim exemption (note that paragraph 4 provides for any other organisation to apply for exemption):
Monthly Review of Portfolio Performance
to 31 October 2018
In October 2018 the average prudential balanced portfolio returned -2.53% (September 2018: -2.00%). Top performer is Investment Solutions (-1.66%); while Prudential (-3.51%) takes the bottom spot. For the 3-month period, Investment Solutions takes top spot, outperforming the ‘average’ by roughly 1.67%. On the other end of the scale Nam Asset underperformed the ‘average’ by 2.09%.
The mainstay of pension investments is failing its duty!
Equities are the mainstay of pension fund investments and comprise the bulk of the investments of the typical prudential balanced portfolios. Equities are expected to return around 6% before asset manager fees. However, when we consider graphs 1.1 to 1.10 in the Monthly Review of Portfolio Performance to the end of October 2018, covering various periods from 20 years to the latest month, it appears that other than the 15 and the 20 year periods, equities have not been able to achieve their expected real return. Adding dividends of around 3% to the returns reflected in these graphs, equities will also have achieved their goal over the 10 year period, the point at which equities had 10 years ago just recovered the losses sustained as the result of the global financial crisis. For all other periods, equities have fallen severely short of their return expectation. Fortunately the prudential balanced portfolio managers move pension fund investments between asset classes by buying in market troughs and selling when markets peak. Looking at the same graphs again it will be noted that the average prudential balanced portfolio has in most instances returned more than inflation plus dividends of around 3% p.a. Still the average prudential balanced portfolio did not return inflation plus 6% for any period up to and including the past 5 years.
It will be no secret to most that the poor performance of prudential balanced portfolios over the past 5 years is the result of the slow unwinding of the global low interest rate environment, which in turn was the result of quantitative easing through large scale asset purchasing programmes of the main central banks in the world. These programmes are being phased out now as the result of which we will see a normalization of the interest rate environment. Interest rates will go up until they represent a fair risk adjusted return relative to equities. In this adjustment phase global equities will remain under pressure.
Looking at various economic metrics it seems like global equity markets have run way ahead of themselves since the global financial crisis and that there is certainly lots of room for adjustment.
Read part 6 of the Monthly Review of Portfolio Performance to 31 October 2018 to find out what our investment views are. Download it here...
Regulator costs in perspective
In Benchtest 09.2018 we dwelled on the onslaught on the pension industry. Amongst others, we referred to two matters of concern, being the possible establishment of an umbrella fund for SOEs and the establishment of the GIPF under its own law. These ideas are promoted by various influential persons who seem to be keen on an umbrella fund for SOE’s.
If the GIPF were to be established under its own law, it will of course no longer be subject to the Pension Funds Act and will most likely not be regulated by NAMFISA anymore. It is highly likely that it will also be moved out of the claws of the proposed National Pension Fund. While this may be a welcome reprieve for Government that would in any event most likely be unable to shoulder the additional mooted contribution burden of somewhere between 10% and 14% of salaries, it does not bode well for the private sector that will be left with little leverage when negotiating its interests in such a scheme. We might as well write off the principles of fairness and efficiency, that the FIM Bill is aspiring to as it will not be possible to realise these should the GIPF and SOE’s no longer be subject to the same rules that apply to the rest of the pensions industry!
If GIPF were to be established under its own law it would only be consistent for its promoters, to also establish the umbrella fund for SOE’s under its own law. These moves would result in the pensions industry currently comprising of roughly 330,000 members and assets of N$ 140 billion, being reduced to 180,000 members and assets of N$ 27 billion. Excluding retirement annuity policies administered by insurance companies, what will be left of the industry is an inconsequential 110,000 members and assets of N$ 21 billion. This will very likely lead to the demise of any effective market mechanism, particularly in the private fund segment.
It will be outrageous if Government were to be the only employer not subject to the laws generally applicable to commerce and industry, specifically with regard to retirement funding.
Prudential balanced or smooth growth portfolio – what should you expect the difference to be?
Smooth growth portfolios are notorious for the lack of transparency. For the employer or individual investor it is really difficult to ‘get a feel’ for the characteristics of these portfolios vis-à-vis financial markets. Most of us have ‘a feel’ for and follow financial markets to the extent that one would know whether financial markets are flying, diving or limping along. An investor would understand his portfolio doing badly when markets have tanked. An investor would start getting disorientated and concerned when his portfolio is doing poorly despite flying markets.
Some investors at times believe there are investment products around that defy the ‘laws of gravity’. Typically the smooth growth portfolios sometimes portray themselves and are seen as being such type of product. Of course thinking rationally about it, no one would really believe anything on earth can defy the laws of gravity. What goes up will come down again! The fundamental principle of every pension fund investment portfolio is that it invests in mostly conventional and publicly priced asset classes, i.e. equity, property, bonds and cash. The parameters are defined in sections 12 and 13 of part 7 of the schedule of regulations, recently promulgated under the Pension Funds Act (previously referred to as regulation 28).
The table above sets out the returns of the Old Mutual AGP (Stable) portfolio, as the most popular smooth growth portfolio, the average prudential balanced portfolio, for the sake of our Benchmark members the Default portfolio and the Allshare Index over various periods as also displayed in graphs 1.1 to 1.7 above. It is to be noted that the OM AGP has not been around for 10 years yet. A few interesting conclusions can be drawn from this table.
Understanding the characteristics of the smooth growth portfolio should make it easier for the investor to decide whether he should invest in a prudential balanced portfolio or a smooth growth portfolio and to then also be comfortable with the results in terms of the portfolio’s performance relative to the market and relative to the typical prudential balanced portfolios without continuously looking over his shoulder and getting uneasy about any under-performance of his portfolio, which is certain to happen from time to time.
So which portfolio should one expect to produce higher returns in the long-term? The old adage of higher risk, higher return will apply, not necessarily to you as an investor because of the fact that timing plays an important role and can distort the results for you. Evidently, a portfolio that does not produce negative returns, presents a lower risk to the investor than one that does and hence should produce lower returns. Now, if the investor is faced with a lower return in one portfolio, it means his counter party is assuming this risk. Given this wisdom, the counter party (Old Mutual, in the case of the AGP portfolio) will charge a premium for assuming this risk. Again in your particular case you may have paid a premium without having had the benefit or vice-versa. That is what insurance is about. You cannot have your cake and eat it, be happy that life treated you well in terms of investment returns and do not expect to get back your premium!
The smooth growth portfolio through ‘manipulation’ of investment returns exposes itself to ‘mispricing’ when prospective returns are likely to be higher or lower than a market value priced portfolio. This is particularly important when the investor considers moving from one type of portfolio to the other. It affords the investor to exploit any mispricing. Smooth growth product providers are quite aware of this risk and have built in contractual terms that try to reduce this risk. In the light of our expectation of markets limping along for quite some time to come, smooth growth portfolios will have little opportunity to prop up returns and to absorb severe negative movements from accumulated reserves. They are thus more likely to track the performance of prudential balanced portfolios, minus the risk premium for some time to come.
Investment choice or investment return smoothing - the chickens are coming home to roost!
In the ‘good old days’ life was still plain and simple, and so were pension funds. Funds did not offer investment choice but managed investment returns through investment smoothing and investment reserves. These reserves allowed funds to maximise investment returns by investing with maximum risk, or the highest possible equity exposure. These portfolios were as good for the new fund entrant as they were for the pensioner. There was no need to be concerned about volatile markets particularly at the most inopportune time for the prospective retiree. There was no timing risk of moving from a high risk to a low risk portfolio just after the market has tanked.
But then came the good years when it seemed that investment markets only move in one direction namely upwards with double digit returns over many successive years. Investment smoothing and investment reserves now fell out of favour and many clever operators realised that the liquidation of the fund’s investment reserve would give their retirement investment a welcome additional boost. This also offered a great opportunity to product providers and advisers to introduce new products and choices to members, at the cost of the member but without really offering the member a better retirement regime. In actual fact members will have most probably been worse off with hindsight, simply on the basis of the principle that their average equity exposure over their working life would not have matched the average equity exposure of funds employing investment smoothing and investment reserves.
Those closely following developments in the SA pension funds industry will be aware that more recently the whole industry is abuzz with a ‘new trend’ towards portfolios offering capital guarantees, or ‘smooth growth’ portfolios. These portfolios were the default many years ago before the move to free-standing private funds. This type of portfolio is conceptually no different to investment smoothing as was employed by all funds in years gone by. Except that these are products offered by insurance companies – at a cost of around 2% per annum, to the member of course, because the member insures against the risk of market volatility which is transferred to the insurance company offering the capital guarantee products. The same can be done within a pension fund at a substantially lower cost. At the same time the fund can invest up to the maximum in equity, the member needs not be confronted with taking an investment decisions on where to invest their retirement capital from time to time and members do not face the timing risk of switching to the right investment portfolio at the wrong time or vice-versa.
To prove the point, one of our ‘old fashioned’ client funds over the period we are able to measure, being 1 May 1998 to 31 December 2017, was able to allocate an average annual return to its members, of 16.2% for a real return of 9% per annum! The average prudential balanced portfolio only managed to generate 13.3% over this period and that does not even account for the likelihood of members having down-scaled risk into lower equity portfolios over this nearly 20 year period, if they were in an investment choice regime! Only one manager actually managed to generate a higher return over this period. Another ‘old fashioned’ fund awarded an average annual return to its members, of 15% over the 22 years from1 July 1996 to 30 June 2018, for a real return of 8% per annum! This takes us back further than what our Namibian investments data base does but I strongly doubt that any member in Namibia in an investment choice regime would have earned anywhere close to this return. We are probably looking at a difference in investment returns of at least 2% per annum which translates to a difference in terminal value for a member earning N$ 200,000 per year of close to N$ 1 million, or one-third more, over a 20 year period!
Pension fund investment regimes are probably no different from fashion. What used to be flavour of the day once will resurrect again at some point in future. If it was left to the trustees, I guess many funds would have been back in the ‘old fashioned’ investment smoothing regime.
What should trustees do if the rules provide for alternative benefits
To say that a pension must be managed strictly in accordance with its rules is stating the obvious. It is probably sometimes not obvious to trustees though, that they cannot make decisions that are not provided for by the rules, either explicitly in terms of specific provisions, or implicitly in terms of general provisions. If neither exists in the rules, trustees would act ultra vires and may be held accountable for any loss the fund or its members may suffer as the result of such action, even in their personal capacity.
But what do trustees stand to do where the rules provide for alternative benefits without giving guidance under what conditions to employ the one as opposed to the other alternative? An example we have recently had to deal with is where the rules in the event of death of the member or pensioner, provide for a member’s or a pensioner’s remaining capital to be paid as a lump sum in terms of Section 37C of the Pension Funds Act, alternatively in the form of a pension to a dependant or dependants of the member or pensioner. No indication is given on any particular priority or preference.
In such instance the rules provide discretion and it is the trustees that need to apply this discretion being the party charged with managing the affairs of the fund. This means that they have to apply their mind before they take a decision they believe to be in the best interest of the beneficiary/ies. To be able to apply their mind with due care, they need to get as much information as possible on dependants and nominated beneficiaries as they would do in the event of being required to decide on the distribution of a lump sum death benefit.
Consulting the dependants and beneficiaries becomes an essential element of the information the trustees need to obtain. When they come to the point of deciding whether to pay the capital in a lump sum or as an income to a beneficiary/ies, Section 37C must first be ignored and must be ‘replaced’ with their discretion that will lead to a rational and defensible decision. However, if the decision is taken that payment as a lump sum is in the best interests of the beneficiary/ies, the requirements of Section 37C now have to be observed.
Pension fund governance - a toolbox for trustees
The following new documents are now available:
The Benchmark Retirement Fund - Flagship of umbrella funds in Namibia
By Paul-Gordon, /Guidao-Oab, Benchmark Product Manager
Can you afford to be invested in the money market?
Investment markets again seem to be at the crossroads where many investors will be asking whether they should remain invested or should move to a secure investment portfolio, after the JSE Allshare index tanked by a cumulative 10.1% (before dividends of 3.7%) over the six month period from 1 May to 31 October and the average prudential balanced portfolio returned exactly 0%!
In the June 2017 performance review we tried to explain how difficult it is to get the timing right for switching to either more conservative, or to more aggressive portfolios and back. Take the last 3 months as a point in case. In August the average prudential balanced portfolio returned a whopping 3.66% for the month! Had you at the time been in the cash portfolio, your return for the 3 months to October would have been 1.9% while the average prudential balanced portfolio would have returned just below 1%. Had you taken the great return for August as your prompt to switch to the average prudential balanced portfolio, you would have sacrificed a cash return over the subsequent 2 month period of 1.2% while the average prudential balanced portfolio would have given you a negative return of 2.9%. So instead of earning 1.9% in the cash portfolio, you will now only have earned minus 2.2%, a difference of 4.1% for switching one month to late. Just missing one month can clearly make a large difference to the outcome and the more often you switch the higher the risk of picking the wrong month and just further adding to your woes!
Switching investments because of last month’s poor or good returns is clearly not the answer. One needs to have a goal and a strategy how to get there. Much like what is implicit in a business’ vision, mission and philosophy. In terms of retirement investment, pension funds are actually structured around the implicit vision that a person should be able to replace his or her income at a rate of 2% of remuneration for each year of fund membership – referred to as income replacement ratio. Empirical evidence suggests that an income replacement ratio of 2% should support a reasonable life style in retirement at a reasonable cost where cost is the contributions required to be made to get there. This replacement ratio is critically dependant on two factors, firstly the net contribution rate towards retirement by employee and employer and secondly, the investment returns earned over the working life. The following table illustrates the interdependency of these two factors.
Assumed NET contribution towards retirement i.e. AFTER all costs for risk and administration etc (as % of pensionable salary)
Assumed net investment return for 30 years before retirement
The greyed blocks indicate where these two factors produce the implicit vision of retirement saving, namely a replacement ratio of 60% after 30 years of service. Prudential balanced portfolios aim to return inflation plus between 4% and 5%, after fees, in the long-term. The table shows that between you and your employer a net contribution rate towards retirement of 12% is required. It also shows that a money market portfolio which is expected to return inflation plus between 1% and 2%, will only get close to the vision if the net contribution towards retirement is raised to at least 16%. So, if you are prepared to pay an additional 4% plus of remuneration towards your retirement fund, you can afford to reduce your investment return objective to inflation plus 2%, i.e. you can afford to move your investment from the prudential balanced portfolio to the money market portfolio and avoid the pain of negative market returns. To put it differently, if your retirement investment has achieved more than inflation plus 5%, do not take that for granted but work on a reversion of returns to the norm. If your retirement investment has achieved inflation plus 2% or less, you will not be able to retire in comfort.
If you have been so fortunate to have accumulated enough capital over 25 years of your working life to secure an income replacement ratio of 3%, you should not be too concerned about the replacement ratio possibly reverting to the norm of 2% over the last 5 working years as this would still be consistent with your initial vision. Yes, it is painful to experience negative investment returns, but if your vision is still on track, the mere prospect of negative investment returns should not seduce you to deviate from your long-term vision and possibly end up having got your timing wrong and having done more harm than good to your long-term vision. And remember, retirement is not the end of your journey. Once you do retire you will still live for many years to come, for a long-term in terms of pension fund philosophy, so no need to be overly concerned about a down turn in investments markets. When you are in the market you will experience pain and you will experience pleasure but when you are out of the market you will miss opportunities while you may avoid pain.
We live in volatile times. We have seen central banks venture into untested and unprecedented monetary experiments without any idea how they will pan out eventually. We will probably still live to see the outcome. We also live in politically turbulent times, so volatility will be around for a while. However we also live in exciting times in terms of the increasing pace of technological advancement. This ‘cocktail’ however will offer many, many opportunities as well – it will not be all doom and gloom but one needs to be versatile and able to adapt quickly.
For some qualified corroboration of our view in this context, refer to the article of 22 November ‘Is Cash King’ by Catherine Robberts of Allan Gray, here...
News from RFS
The RFS team – the recipe for success!
A pension fund has a life much, much longer than a human being. As service provider to a pension fund, corporate memory of a service provider vis-à-vis the fund can make an important contribution to the management of the fund. RFS appreciates the importance of this differentiator and therefor makes a point of building and maintaining corporate memory on behalf of our pension fund clients. In this regard a conducive office atmosphere and environment and conducive policies support our effort to retain our staff which is essential in this endeavour.
In addition RFS differentiates itself by the depth of its staff with pension fund relevant qualifications and experience.
The following table presents these key differentiators in figures:
We are proud of this record and extend our sincerest gratitude to those staff members who have faithfully served the company and its clients over more than 10 and more than 15 years and express our sincere gratitude to each one of them for their dedication and commitment to our cause:
Staff with 10-years’ service
Pension fund industry meeting of 17 September 2018.
An interesting observation on the attendance at this meeting is that 12 (one half of RFS client base) out of 18 funds (20% of all private funds) represented at the meeting are RFS clients. It is also interesting to note that some of RFS competitors were not represented at all. Does this indicate that RFS takes greater interest and is more successful in mobilising its clients, on matters affecting their funds and the industry?
Following are the more noteworthy matters that arose at the meeting:
NAMFISA awaits passing of FIM Bill with optimism
“Namibia Financial Institutions Supervisory Authority (Namfisa) senior officials are confident that the long-awaited Financial Institutions Markets Bill (FIM Bill) will clear a lot of grey areas in the regulation of the non-banking financial sector. The FIM Bill seeks to consolidate and harmonise laws regulating financial institutions and markets in Namibia. It is also expected to introduce a Financial Services Adjudicator, who will settle disputes between consumers and service providers. NAMFISA CEO, Kenneth Matomola, explained to the Windhoek Observer that the current legislative instruments are old and ineffective to support the efficient, fairness and orderly operation of the country’s financial system.” – Windhoek Observer
News from the market
Melbourne Mercer Global Pension Index – Chile’s DC system ranks amongst the highest in the world!
This 2018 Melbourne Mercer Global Pension Index (MMGPI) was recently published. The Index measures the retirement income systems for 34 countries against more than 40 indicators. These include sub-indices measuring the adequacy, sustainability and integrity of the retirement system.
South Africa’s index value currently stands at 52.7, a slight increase in comparison to its rating of 48.9 in 2017. The country’s index rating falls within the range of developing countries including Brazil, Indonesia and Malaysia as well as developed countries like the USA, Austria, Spain and Italy. By far the highest rated pension systems are those of the Netherlands with a rating of 80.3 and Denmark with a rating of 80.2. The lowest rating of 39.2 is that of Argentina.
The purpose of the index is to provide a benchmark against which countries can measure their retirement income systems. Every country has its own unique economic, social and political circumstances. Nevertheless, every country can take action and move towards a better system. In the long-term, there is no perfect pension system, but the principles of ‘best practice’ are clear.
Interestingly, in the light of the reported dogmatic views of adviser of the Minister of Labour, against a defined contribution system, Chile, which in fact only offers a defined contribution system has a rating of 69.3 which places it in the second best category together with countries like Singapore, New Zealand, Sweden and Germany.
Download the executive summary of this report here...
Although Namibia has a very similar system to SA, the SA social pension is significantly better that Namibia’s and Namibia can hence be expected to be rated worse than SA.
The price of fuel – do you know what you pay for?
The latest fuel levy was set in Government Gazette 6762 of 7 November 2018 and reflects an interesting composition of the price of fuel as per below table. The total for Namibia is based on an estimated annual consumption of 1 billion litres of fuel in Namibia.
(for stakeholders of the retirement funds industry)
How South Africans perceive their retirement
This article reviews a study based on face-to-face interviews with 345 South Africans between the ages of 55 and 85 living in major metropolitan areas. It was conducted in July and August. Sixty-one percent of respondents were still working while 39% were retired. Here are some interesting findings of the study:
Mass resignation of board members not an admission of guilt
The resignation of half the board of trustees of the Private Security Sector Provident Fund was the result of an instruction by the North Gauteng High Court. The instruction by the court was the result of the FSCA had been investigating allegations that the fund was being mismanaged and that the policy of a per-meeting fee was being abused by some trustees which resulted in heavy financial losses to the fund. It was found that some trustees were being paid R7900 for attending a single board meeting and R5768 for a subcommittee meeting. The FSCA added that there were more actual meetings than the ones planned. In June 2017 there were 19 planned meetings, when it fact 66 were held, resulting in one trustee pocketing R190000 in that month alone. As a result of this and other financial mismanagement issues, the FSCA launched a court application to have the fund put under administration.
Read the article by Lindile Sifile in IOL of 31 October 2018, here...
Investors have given up on the JSE – does that mean it’s time to get in?
“To the end of September this year, just six companies in the FTSE/JSE Top 40 had made any gains in 2018. Five of those are resource counters, responding to a single theme. The sixth is Investec, which has gone up on the back of the announcement that it will be unbundling its asset management business.
Overall, that makes for a pretty dismal market, and it doesn’t get any better if one looks more broadly. According to analysis by Denker Capital, almost 40% of stocks in the FTSE/JSE All Share Index (Alsi) are currently trading at prices below where they were five years ago… given how much prices have come down, there is more value across the market than… seen for over half a decade. The projected return on our portfolio is the highest today it has been at any point in the last six years… And this is a fundamentally-driven return, coming from dividends and earnings.”
Read the article by Patrick Cairns in Moneyweb of 29 October 2018, here...
(for investors and business)
Where to find investment growth in the current economy
“...You can’t just deploy your assets offshore and think the job is well done,” says Natalie Phillips, deputy managing director at Investec Asset Management South Africa.
Neither is merely diversifying into another currency... Investors need to consider their situation holistically when deciding how to complement their South African investments with an offshore component...
Should you consider a testamentary trust?
“...For some, a testamentary trust could be a considerably more effective estate planning tool, which Fourie feels is much neglected despite that it can achieve most of the normal estate planning goals like safeguarding the future of family members, minimising a tax burden or planning for the incapacity of elderly persons or children with disabilities. So, should you consider it for your own estate planning?
Bear in mind that the article makes reference to SA tax law that is different in Namibia and estate duty that does not apply in Namibia. Some of the principles covered in the article however are relevant to any person in Namibia.
Stats of the day
(Will we see an orange fill within the Namibia borders soon?)
From Capricorn Asset Management Daily Brief.