|In this newsletter:
Benchtest 11.2018, season's greetings, comments on IT Act changes, Prescription Acts and unclaimed benefits and more...
Important notes and reminders
Update on proposed amendments to the IT Act
If you have missed the news release, you can download it here...
I would like to thank each and every staff member for their contribution and of course these clients for having once again entrusted RFS with the responsibility to administer their funds for another tenure.
Monthly Review of Portfolio Performance
to 30 November 2018
In November 2018 the average prudential balanced portfolio returned -1.73% (October 2018: -2.53%). Top performer is Hangala Prescient Absolute Balanced (-0.24%); while Allan Gray (-3.94%) takes the bottom spot. For the 3-month period, Investment Solutions takes top spot, outperforming the ‘average’ by roughly 1.94%. On the other end of the scale Nam Asset underperformed the ‘average’ by 2.15%.
It’s the dog that wags the tail - how the US economy impacts SA (and Namibia)
The US Repo rate is currently 2.25%.While the US annual CPI has steadily been creeping up from around 0% in January 2015 to 2.95% at the end of July, it has been on the decline again since then, contrary to the Fed’s expectation, to reach 2.18% at the end of November. This means that any US citizen investing in US treasuries is now for the first time since November 2015, earning a positive real interest rate. If this trend continues, the appetite of US investors for equities is likely to wane, removing the underpin of equities in the US and globally. The declining inflation in the US is probably also at least part of the reason why the Fed has no raised the repo rate at its last sitting, contrary to a general expectation that it would. The US needs inflation to deflate its huge debt burden and expected quantitative easing to do this job. It seems though that this strategy has not worked and the risk of deflation is on the rise. This may present major structural challenges and may result in us treading a very uncertain path and in increased market volatility.
A negative real interest rate is clearly not sustainable and is the cause of artificial imbalances in asset valuations that are due to correct once the situation returns to normal as we are starting to see now. The US repo rate should be around 1.5% higher than US CPI, going by historic evidence stretching back to 1988 and up to the onset of the global financial crisis. Based on current US CPI of 2.2%, the US repo rate should be around 4%. Once the repo rate offers a real return of 1.5% or reaches 4% under current inflationary conditions, it would indicate a normalised interest rate environment. At the more recent rate of upward adjustment of the US repo rate and the state of the global economy we are once again looking at around 3 to 4 years now until we reach this point given that we saw 6 increases of 0.25% each over the past 4 years. This of course assumes that the global economy will pick up at the speed it has over the past 4 years, whereas at the moment it could go in either direction. So where will this leave SA?
Read part 6 of the Monthly Review of Portfolio Performance to 30 November 2018 to find out what our investment views are. Download it here...
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.
Graph 1 clearly shows that the SA CPI adjusted ALSI has been at dizzy heights relative to its 30 year historic levels, even though it does depict sideward movement since 2014 and a sharp downward correction of late. From 1987 up until 2003 the market and the P:E ratio were very closely correlated and the gap between the two was small. The first run up to the peak of the financial crisis was caused by the commodity run that benefited earnings of SA equities significantly. The subsequent run up to another peak was the result of the low interest rate environment through which the high earnings of the commodity run were largely maintained. Furthermore, the price earnings ratio of 15.4 currently is also still above its long-term average of 14.7. This is the multiple of earnings investors are prepared to pay for a share. Earnings are still high with lots of room for correction while the price investors are prepared to pay for these earnings also implies room for a downward correction of around 5%. Will a recovery of global commodities be the saving grace for SA, offering an underpin to the Allshare Index? Now let’s look at some indicators that could provide an answer to this question.
Graph 2 shows how closely correlated the oil price has been to the SA Allshare Index until the bottom fell out of the oil price and other global commodities simultaneously. Since then the gap between these two lines has closed, indicating that at the oil price as at the end of October, commodities and low interest rates provided support to the SA Allshare index.
We know that the US Fed rate is on an incline while at the same time global growth does not show any signs of a synchronized global economic recovery and it is unlikely that global commodity prices will recover soon. SA Reserve Bank increased the repo rate by 0.25% in early November, while the oil price has also fallen sharply since end of October. Both indicators will put pressure on company profits thus offering no reprieve to the SA Allshare Index.
Graph 3 depicts the same metrics in the US and it shows very similar trends. The 30 year average P:E of the S&P 500 is 22.3 which is above its current level of 19. In historic terms it seems that US investors are not as exuberant about US equities as SA investors are about SA equities but earnings are very high, representing the gap between the two lines that has really manifested itself since the introduction of quantitative easing. Again we know that US interest rates are on the rise, putting pressure on company earnings. At the same time it seems that the reduction in company tax rates and other fiscal measures taken by the Trump administration have been factored into share prices and offer no further support to US equities going forward. So the US market is similarly due for a correction. The question is whether a correction of the US market will impact SA equities.
Graph 4 shows that US and SA equities are fairly well correlated. The divergence up to the middle of 200 it to be ascribed to the tech bubble in which SA equities did no really participate either on the up or on the down. Since that bubble burst the markets moved in tandem for a long time until the first utterances in 2014 of the phasing out of quantitative easing and the lifting of interest rates where US equities continued to steam ahead while SA equities limped along. The conclusion one may draw from this is that a correction of the US market will impact the SA market. Although one may expect that the US Fed will try to manage the US economy in such a way that there will not be any rapid correction, it cannot control events happening everywhere in the world that may lead to a panic reaction and a rapid correction of markets.
The Fed rate is at the core of the future movement of global equities until all measures that have been placing a cap on global interest rates have been removed from the system. The US Fed rate is currently at 2.25%, while US CPI has steadily been creeping up to 2.52% at the end of October. Long-term statistics indicate that the Fedrate should be roughly 1% to 2% higher than CPI. Based on current CPI, a US Repo rate of around 1.5% above CPI, or around 4% would indicate a normalised interest rate environment. At the more recent rate of upward adjustment of the Fed rate we are still looking at around 2 to 3 years now until we reach this point. Let’s continue keeping an eye on this.
Comments on proposed changes to the Income Tax Act
Inland Revenue recently circulated proposed changes to the Income Tax Act to various industry bodies and invited comments from these bodies. The principle of inviting comments on proposed Income Tax Act changes can only be welcomed. We have submitted the following comments. Readers should be able to deduce from these comments what the proposed changes entail and what they do not entail.
An explanatory memorandum to the proposed changes can be downloaded here...
Pension fund governance - a toolbox for trustees
The following documents can be further adapted with the assistance of RFS.
News from RFS
The RFS team in festive mood
Some action photos from the 2018 year-end function / family day:
Impatiently waiting for the action to start.
Father Christmas on his rounds
Attentively listening to the formal parts before lunch
The social 2018 committee arranged the day
The 2018 ‘RFS Fairy’ for assisting colleagues beyond the call of duty – Milton Mentile!
News from NAMFISA
Tabling of FIM Bill postponed?
Microlending legislation was to be overhauled by the FIM Bill, as will many other non-banking financial services laws. However due to it having been considered more urgent than the other financial services laws, it was removed from the FIM Bill and was promulgated separately on 31 July 2018 and commenced on 15 October 2018.
We understand that industry stakeholders are challenging the Microlending Act and certain principles on the basis of them being inconsistent with the Namibian Constitution. Since the same principles are at play in the other financial services laws contained in the FIM Bill it appears that the Minister of Finance may after all not table the FIM Bill in parliament until the current legal challenge of the Microlending Act has been resolved by the court. How long this case will take to be resolved cannot be foreseen at this stage.
Unclaimed benefits and the Prescription Act
An opinion by Andreen Moncur
The Prescription Act is applicable to retirement fund benefits and not the Administration of Estates Act. Sections 37B and 37C of the Pension Funds Act respectively expressly provide that a pension benefit is not an asset in a member's insolvent or deceased estate. The Act also expressly exempts registered funds from the provisions of the Trust Moneys Protection Act, 1934.
Where lump sum death benefits are dealt with under section 37C, there can be no unclaimed moneys remaining in a pension fund after completion of the 37C process, as all moneys must be paid either to an identified dependant and/or nominee or to a nominee and/or the deceased member's estate or to the Guardian's Fund.
The Administration of Estates Act specifically deals with deceased estates, the administration of testamentary trusts and the administration of the property of minors and other persons under curatorship. Said Act does not deal with pension benefits. More specifically, section 93 of said Act does not apply to retirement funds as a pension benefit is not trust property held by the fund in terms of a mandate from a deceased person. A retirement fund is not an executor of a deceased estate, nor a trustee of a testamentary trust, nor a curator or tutor of a minor or other person under legal disability. Furthermore, until a benefit from a fund has actually prescribed in terms of the Prescription Act, it cannot be said to be an unclaimed benefit.
In terms of the Prescription Act, a beneficiary's claim against a retirement fund for a benefit accruing to such beneficiary from the fund prescribes 3 years after the date on which the benefit became payable. However, in terms of Common Law and more recently in the light of the Constitutional requirements of equity and administrative fairness, a benefit prescribes 3 years after the date on which the beneficiary became aware or ought reasonably to have become aware of his right to such benefit. There are numerous SA adjudicator examples of condonation of late claims, especially where the claimant is situated in a rural area or has a low level of formal education.
For the reasons set out above, I usually draft fund rules to provide that moneys (other than death benefits distributed under section 37C remaining unclaimed after 3 years from date of falling due for payment must be paid to the Guardian's Fund administered by the Master of the High Court for the account of the relevant beneficiary. This means that if there is a claim after 3 years but before 30 years has elapsed, the beneficiary will be able to access their benefit. After 30 years, the benefit will revert to the State.
Benefit prescription practice and principles
While we are on the topic of unclaimed benefits and the Prescription Act (refer preceding article) Personal Finance magazine had an article on this topic that also makes for interesting reading.
Here are the key principles revealed in the article:
News from the market
Allan Gray explains its disappointing returns
Allan Gray delivered very disappointing returns of minus 3.6% over the 12 months and minus 7.6% over the 3 months to 30 November 2018.
Find an explanation by Andrew Lapping, chief investment officer, here...
(for stakeholders of the retirement funds industry)
How to improve SA’s pension system
In last month’s newsletter we referred to the Melbourne Mercer Global Pensions Index report that rates South Africa fairly low and although not listed, Namibia would be rated even lower due to a substantially lower social pension. Here are a few recommendations on how SA can improve its pension system, all of which are equally relevant to Namibia and should be taken to heart by ‘the powers that be’:
Does the way we think about retirement still make sense?
“The traditional concept of retirement – where people save for several decades, retire at 60 and die a few years later – is being turned on its head by increases in longevity and the growing medical needs associated with it. Many people do not have enough money to maintain their standard of living in retirement and although they may still like to work, they may not have the opportunity to do so. Sunél Veldtman, CEO of Foundation Family Wealth, says the western way of thinking suggests that people only have financial independence if they can look after themselves. “The fact is that in the future, that picture of retirement also will change. Very few people will be able to look after themselves from what I’ve seen out there,” she told attendees at Moneyweb and Liberty’s Retire Well Masterclass… “I’m dealing with this every single day in my office. Real problems that clients have is: ‘My children want to start a business.’ ‘My wife’s sister needs an urgent back operation. She is not on medical aid.’ Those are the real questions that people have that really impact their retirement.”…“Why can we not design a retirement product which creates an annuity flow for a group of people, because that is how it has always been. Why must retirement focus on the individual? Why can we not have a family retirement policy?...”
Read the full article by Ingé Lamprecht in Moneyweb of 26 November 2018, here...
(for investors and business)
Rational investors can benefit in times of panic
“I recently came across an article in a local newspaper titled ‘JSE nears worst monthly performance in 10 years’. When headlines like this start appearing, I always think of the cycle of irrational panic that times like these trigger among those investors who succumb to emotions.
Generally, significant price declines trigger fears in investors. They are unable to think rationally, to the point where they will happily avoid any possibility of further loss – so they sell low. However, this point, when the fear is at its strongest and prices are at the bottom of the cycle, is exactly where the potential upside is the greatest…
Intelligent Investors stick to timeless investment principles that underpin sustainable, long-term returns.
Read the article by Kokkie Kooyman in Moneyweb of 23 November 2018, here...
Why we all make bad investment
“…Most investors will probably react to a market crash with a mixture of fear and panic. In fact, many will sell out of their holdings, locking in the losses that have just occurred. Yet history has repeatedly shown that the periods after big market downturns can be the most rewarding…
Logically, if you can buy shares at heavily discounted prices, your potential future returns must be much higher. For most investors, however, the focus is on what just happened, rather than its implications for what is likely to happen next…
“We really have two selves,” Kemp explains. “Two processes. Two patterns of thought.”
Unimaginatively, Kahneman calls these ‘system one’ and ‘system two’. When operating in system one, we are entirely responsive, selfish and even instinctual. In system two we are logical, thoughtful and slow-moving.
While it might seem that system two is always preferable, they actually both have their place…
Having a plan
It might be easy to say that all you have to do is block out the noise, but that’s almost impossible in a modern world where information is so pervasive. You won’t be able to escape the news or the social media posts or the talk around the office, so you need to have a plan for how you will stop yourself from reacting to it.
Kemp recommends starting off by having a set of investment principles that must guide every decision you make. If these are sound and reasonable, they will stand up even when markets turn against you.
It’s also important to think about how you are looking at the data you have. If a market falls significantly, expected future returns must go up. Which side of that equation are you paying more attention to?
A checklist can also be incredibly powerful. When making any investment decision, go through your checklist to see if it meets the criteria you set out – such as whether they reflect your principles, are they long-term focused, and are they valuation driven…”
Read the full article by Patrick Cairns in Moneyweb of 23 October 2018, here...
Stats of the day
From Capricorn Asset Management Daily Brief of 13 November 2018.