Annuitisation challenge

Blending science and human behaviour

Jaco van Tonder

April 2020

2

Important information

All information and opinions provided are of a general nature and are not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information or opinion without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security.

Collective investment scheme funds are generally medium to long term investments and the manager, Ninety One Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing and scrip lending. The fund may borrow up to 10% of its market value to bridge insufficient liquidity. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant TER. Additional information on the funds may be obtained, free of charge, at www.ninetyone.com. Ninety One SA (Pty) Ltd (“Ninety One SA”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA).

Investment Team: There is no assurance that the persons referenced herein will continue to be involved with investing for this Fund, or that other persons not identified herein will become involved with investing assets for the Manager or assets of the Fund at any time without notice.

Investment Process: Any description or information regarding investment process or strategies is provided for illustrative purposes only, may not be fully indicative of any present or future investments and may be changed at the discretion of the manager without notice. References to specific investments, strategies or investment vehicles are for illustrative purposes only and should not be relied upon as a recommendation to purchase or sell such investments or to engage in any particular strategy. Portfolio data is expected to change and there is no assurance that the actual portfolio will remain as described herein. There is no assurance that the investments presented will be available in the future at the levels presented, with the same characteristics or be available at all. Past performance is no guarantee of future results and has no bearing upon the ability of Manager to construct the illustrative portfolio and implement its investment strategy or investment objective.

In the event that specific funds are mentioned please refer to the relevant minimum disclosure document in order to obtain all the necessary information in regard to that fund.

This presentation is the copyright of Ninety One SA and its contents may not be re-used without Ninety One SA’s prior permission.

GENERIC ADVISOR DISCLAIMER SA ONLY

3

The science challenges underlying retirement

“Today’s low annuity rates, closure of increasing numbers of defined benefit schemes and the Pension Freedoms, introduced by the UK Government in 2015, ripped up the retirement income planning rulebook” – FinalytiQ 2018

Research report findings

Not a uniquely South African problem

4

Arriving at a sufficient pension pot

A journey that takes a lifetime

15% of pre-tax salary

40 years of employment

20 x income required at age 60

30% of pre-tax salary

30 years of employment

20 x income required at age 60

60% of pre-tax salary

20 years of employment

20 x income required at age 60

There are no quick fixes for lack of retirement savings

5

Arriving at a sufficient pension pot

Milestones along the way

Source: In-house retirement projection model

0

5

10

15

20

25

20 25 30 35 40 45 50 55 60

Mul

tiple

of s

alar

y to

hav

e sa

ved

up a

t age

Age

6

Pensioner needs

Pensioners are not the same as other investors

Research report findings

Pensioners have different needs and risks, which make a different approach imperative

Need: cash flows‒ A pensioner wants to draw a regular income that will increase with inflation over time

Risk: the money runs out‒ How long will I live?‒ Retiring in a bear market?‒ Investment return/risk

Impact of Risk - Psychology‒ Unlikely that pensioners will be able to go back to work to make more money‒ If the income strategy fails, fall-back position is government, family and friends – not

ideal

When has an investor saved enough for retirement?

8

When have you saved enough?

Typical situation facing financial advisors today

Research report findings

Have I saved enough for retirement(i.e. income required < 5% pa)?

NoYes

I need more than 10% paI need between 5% and 10% income pa

A few areas to get right

Managing a living annuity

10

Read our entire living annuity insight series

Visit ninetyone.com/en/south-africa/how-we-think/insights

Principles for income selection

Managing a living annuity

12

Managing income

Two key principles

Research report findings

Know whether an income level is green, orange or red

A flexible income increase strategy helps a lot!

13

Picking the safe income for the annuity term

Source: Ninety One proprietary model. Research report findings

0%

10%

20%

30%

40%

50%

60%

70%

2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5%

Prob

abilit

y of

failu

re

Initial annuity income rate

30 year terms 10 year terms

Know whether your income is green/yellow/red

A key driver of annuity success

Managing annuity portfolios

15

Managing assets for long-term income portfolios

A key piece to success recipe

Research report findings

Growth assets exposure – how much?

Offshore exposure – is it needed and why?

Volatility – how much does it matter for income investors?

16

Growth asset exposure – how much?

Growth assets drive success

Ninety One proprietary model. Research report findings

0%

10%

20%

30%

40%

50%

60%

70%

80%

2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% 7.0% 7.5%

%

Income% selected

% Growth Assets (75% capped) % Failure with 75% growth cap

Income from 4% and up require more growth asset exposure

17

Growth asset exposure – how much?

Impact of reducing growth asset exposure to buffer volatility

Ninety One proprietary model. Research report findings

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% 7.0% 7.5%

%

Income% selected

75% Growth asset cap 40% equity cap

18

Offshore exposure

Not a luxury – a necessity for a growth engine

Source: Ninety One proprietary model. Research report findings

29.5% 27.5%31.2% 31.7%

28.4%

42.0% 42.2%

33.5%

22.2% 22.0%

2.6%

11.8%

14.9%

24.8%

46.0% 33.0% 32.2% 41.3% 52.7% 52.6%

0%

10%

20%

30%

40%

50%

60%

70%

80%

2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% 6.5%Income% selected

Foreign Equities Local Equities

For higher incomes, MA: High Equity funds more appropriate

19

What is the value of volatility?

Sensitivity of maximum income to real return and volatility

Research report findings

Portfolio Real Return Additional income per

Real Standard Deviation 5% 6% 7% 8% 1% real return

10% 4.00% 4.90% 5.85% 6.80% 0.93%

11% 3.67% 4.60% 5.60% 6.50% 0.94%

12% 3.40% 4.40% 5.30% 6.20% 0.93%

13% 3.10% 4.10% 5.00% 5.95% 0.95%

14% 2.80% 3.80% 4.70% 5.60% 0.93%

Additional income per 1% risk reduction

0.30% 0.28% 0.29% 0.30%

Volatility has about a third of the impact of real return for pensioners

20

Role of active management

Whilst active managers have been considered for their outperformance levels, they have not been considered for the better risk characteristics

Research report findings

‒ An investors income rate of 4.5% can increase to 6.0% if they invest in a portfolio that over the long term can add 1% p.a. return and 2% p.a. lower volatility

Return increase by 1%

0.93% more income

Volatility down by 1%

0.3% additional income

Active management can impact investor outcomes significantly

21

Not every fund has a clear volatility objective

Case study of 20 year numbers for multi-asset unit trusts

Past performance should not be taken as a guide to the future, losses may be made. Data is not audited. Source: Morningstar and Investec Asset Management – Feb 1998 to Feb 2018, research report findings Returns are calculated on a NAV-to-NAV basis, for R class, with gross income reinvested, since inception. Highest and lowest 12-month rolling performance since inception is 61.0% and -15.7% respectively for the Investec Opportunity Fund and 48.0% and -22.9% for the Investec Managed Fund.

Annualised real return

(ASISA) South African MA High Equity

Investec Managed Fund

Investec Opportunity Fund

Competitor A

Competitor B

Competitor C

Competitor D

11%

12%

13%

14%

15%

8.0% 8.5% 9.0% 9.5% 10.0% 10.5% 11.0%

Retu

rns

p.a.

Standard Deviation p.a.

It would appear that there is 3% volatility to play with!

22

The impact of volatility

Real value of accumulated assets with 4.5% income

Past performance should not be taken as a guide to the future, losses may be made. Data is not audited. Source: Morningstar and Investec Asset Management – Oct 1997 to Dec 2017, research report findings performance figures above are based on lump sum investment, NAV based, net of R class and A class fees, inclusive of all annual management fees but excluding any initial charges, gross income reinvested, fees are not applicable to market indices, where funds have an international allocation this is subject to dividend withholding tax, in South African Rand. Highest and lowest 12-month rolling performance since inception is 61.0% and -15.7% respectively for the Investec Opportunity Fund and 48.0% and -22.9% for the Investec Managed Fund.

R1,995,205

R5,389,705

R0

R1,000,000

R2,000,000

R3,000,000

R4,000,000

R5,000,000

R6,000,000

R7,000,000

Dec

-97

Aug-

98

Apr-

99

Dec

-99

Aug-

00

Apr-

01

Dec

-01

Aug-

02

Apr-

03

Dec

-03

Aug-

04

Apr-

05

Dec

-05

Aug-

06

Apr-

07

Dec

-07

Aug-

08

Apr-

09

Dec

-09

Aug-

10

Apr-

11

Dec

-11

Aug-

12

Apr-

13

Dec

-13

Aug-

14

Apr-

15

Dec

-15

Aug-

16

Apr-

17

Dec

-17

AUM

in liv

ing

annu

ity (Z

AR) i

n re

al te

rms

(ASISA) EQ General 4.5% (ASISA) MA High Equity 4.5% (ASISA) MA Medium Equity 4.5%Investec Managed (A & R) 4.5% Investec Opportunity (A & R) 4.5% (ASISA) MA Income 4.5%

Cumulative return

R3,434,5005.5%pa

Practical implications for advisor

Pulling it all together – behavioral management

24

Pulling it together

Living Annuities - Learnings from the myths

Research report findings

Lack of retirement savings remains a crucial SA problem

A living annuity needs a proper growth engine

If income > 5% pa – structurally different portfolio required

A living annuity needs proper offshore exposure

Portfolio volatility very important!

25

But markets can be crazy at times! How do you manage sequence of return risk?

26

SA equities underperforming cash over 5 years

But this actually happens more frequently than people remember!

Source: Rolling 5-year performanceDMS Dataset and Investec Asset Management in-house model to December 2019

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

1904 1909 1914 1919 1924 1929 1934 1939 1944 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009 2014 2019

SA Cash SA Equity

It has happened 25 times since 1900

27

When are annuities most prone to failure?

Failed 5% income annuities relative to 10 year SA equity real return

Source: DMS data series and Investec in-house model. SA Equity rolling returns show the return pa achieved by SA equity indices in the first 5 years following inception of the annuityAnnuity failure assumes 5% initial income and optimized portfolio asset allocation

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

-20%

-10%

0%

10%

20%

30%

40%

50%

1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

??

Retiring at the start of an extended period of low real returns on equities is a problem

28

How do you mitigate sequence of return risk?

Phase in – even over a period as long as 3-5 years!

Don’t retire at the start of a bear market!

29

Are bucket strategies useful …. In managing sequence of return risk?

30

And what about bucket strategies?

Do they improve your chances of success?

NO, but wait No - Asset allocation and volatility drive success

But we are also dealing with human beings here!Bucketing does have psychological value

31

And what about bucket strategies?

What to watch out for if you use them?

Beware of overexposure to fixed income assets

Rebalance regularly – preferably on anniversary

Phase new pensioners into the market in a structured way

Don’t forget that offshore reduces volatility

Thank you

33

Modelling setup

– Actual historical 30-year rolling returns of major asset classes from 1900

– Assume 1% fee for advice and annuity admin

– Assume asset management fee = alpha

– Measure ability to:

– Keep income stable in real terms (5% tolerance)

– Protect buying power of income (max 30% reduction over 30 years)

– Optimise portfolio asset allocation for growth assets

Research Report Findings

34

Important information

All information and opinions provided are of a general nature and are not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information or opinion without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security.

Collective investment scheme funds are generally medium to long term investments and the manager, Ninety One Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing and scrip lending. The fund may borrow up to 10% of its market value to bridge insufficient liquidity. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant TER. Additional information on the funds may be obtained, free of charge, at www.ninetyone.com. Ninety One SA (Pty) Ltd (“Ninety One SA”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA).

Investment Team: There is no assurance that the persons referenced herein will continue to be involved with investing for this Fund, or that other persons not identified herein will become involved with investing assets for the Manager or assets of the Fund at any time without notice.

Investment Process: Any description or information regarding investment process or strategies is provided for illustrative purposes only, may not be fully indicative of any present or future investments and may be changed at the discretion of the manager without notice. References to specific investments, strategies or investment vehicles are for illustrative purposes only and should not be relied upon as a recommendation to purchase or sell such investments or to engage in any particular strategy. Portfolio data is expected to change and there is no assurance that the actual portfolio will remain as described herein. There is no assurance that the investments presented will be available in the future at the levels presented, with the same characteristics or be available at all. Past performance is no guarantee of future results and has no bearing upon the ability of Manager to construct the illustrative portfolio and implement its investment strategy or investment objective.

In the event that specific funds are mentioned please refer to the relevant minimum disclosure document in order to obtain all the necessary information in regard to that fund.

This presentation is the copyright of Ninety One SA and its contents may not be re-used without Ninety One SA’s prior permission.

GENERIC ADVISOR DISCLAIMER SA ONLY