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Investment Options: Cornelius SchooneesBusiness Development Actuary, Absolute Return Investments
“How to get downside protection in uncertain markets – without missing the upside”
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If you're not confused, you're not paying attention.
- Tom Peters
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Why uncertainty matters to the private investor
How to deal with uncertainty
An alternative to Money Market Funds
Key messages
Agenda
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Market declines can be unsettling and detract investors from a sound long-term investment strategy
As markets decline, each savings withdrawal becomes a larger slice of the remaining savings
Each withdrawal locks in low fund values
With a smaller pool of savings, the potential for future income is reduced and it takes longer to recover from market downturn
Why uncertainty matters
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Withdrawals become bigger slices of savings
Withdrawal No. of units x Unit price=
R1,000 1.00 x R1,000=
1.11 x R900=
1.25 x R800=
1.43 x R700=
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Taking withdrawals amplifies market losses…
Units redeemed for fixed monthly income
Top40 units:
1.01 1.03 1.02 1.01 0.99 0.99 1.00 0.99
1.21 1.46 1.70 1.71 1.73 1.86 2.17 1.94
Capital Builder units:
Impact of market decline on unit price
-39%
Impact of market decline on number on units
-7%
Capital Builder
TOP40 index
1.00 1.03
1.05 1.19
Impact on unit price
Impact on no. of units
10.1
16.0
Source: OMIGSA
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While all investors face the risk of market declines, investors that make withdrawals are particularly vulnerable
Lock-in of low fund values means it takes longer to recover from a market downturn
Resulting in longer time to recover
Rate of return
Size of bear market downturn
-10% -20% -30% -40% -50%
2% 5 yrs 11 yrs 18 yrs 26 yrs 35 yrs
4% 3 yrs 6 yrs 9 yrs 13 yrs 18 yrs
6% 2 yrs 4 yrs 6 yrs 9 yrs 12 yrs
8% 1 yrs 3 yrs 5 yrs 7 yrs 9 yrs
10% 1 yrs 2 yrs 4 yrs 5 yrs 7 yrsNote: Calculation based on continuous compounding and recovery time rounded to nearest year
Source: OMIGSA
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Understand macro picture
Understand asset-specific picture
Diversify to address asset-specific risk
Protect capital against downside risk through selective use of put options
Build a safety margin (alpha returns) through active management
How to deal with uncertainty
There are 5 key steps...
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Protect capital against downside risk
Relative return strategies do not protect capital and tend to move in the same direction as a benchmark
Absolute return strategies aim to protect capital by pursuing positive returns with less volatility over time
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Historic demand for Absolute Return funds
Strong net inflows and large growth in number of funds prior to market decline
Source: Micropal and Association for Savings and Investment SA (ASISA)
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More recently flows have shifted to Money Market
In 2008 some 81% of unit trust net inflows went into money market funds (up from 29.3% in 2007)
High degree of risk aversion following market decline
Prospects of poor returns as interest rates decline
Source: Association for Savings and Investment SA (ASISA)
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An alternative to Money Market Funds
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RiskRisk
Targets quarterly positive returns
Targets Cash + 3% p.a. (gross) over rolling 3 year period
Capital BuilderFund objectives
ReturnReturn
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EX
PE
CT
ED
R
ET
UR
NS
High
Low
Stable VolatileCONSISTENCY OF QUARTERLY RETURNS
RISK
RETURN
Cash
AbsoluteReturnFunds
VariableIncomeVariableIncome
CapitalBuilder
BalancedFunds
Capital BuilderFund positioning
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Invest in 15-25 large cap shares (generally components of the Top 40 index)
Tracking error to the TOP40 between 2% - 4%
CASH + MONEY MARKET
25%
Capital BuilderProcess - How the fund works
PHYSICAL EQUITY
75%
Base case
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Physical equity is hedged with listed TOP40 put options
Generally 1-year options are used and rolled quarterly to lock in gains
CASH + MONEY MARKET
25%
Capital BuilderProcess - How the fund works (continued)
EFFECTIVE EQUITY
0-40%
Base case
CASH-EQUIVALENT
HEDGED EQUITY
35-75%
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Capital BuilderPerformance history since inception
Notes:Returns until February 2008 are based on the Capital Builder institutional portfolio, while returns from March 2008 onwards are the unit trust returns (gross of unit trust related fees).
Targets gross return of Cash + 3% over rolling 3 year period
100
110
120
130
140
150
Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09
Cash (9.2%)
Cash + 3%
Capital Builder (11.7%)
Source: OMIGSA
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Capital BuilderPerformance history since inception
TAX QUARTERSTAX QUARTERS(Dec 05, Jan, Feb 06)(Dec 05, Jan, Feb 06) (Dec, Jan, Feb 09)(Dec, Jan, Feb 09)
Aims for quarterly capital protection
Note: Returns until February 2008 are based on the Capital Builder institutional portfolio, while returns from March 2008 onwards are the unit trust returns (gross of unit trust related fees).
8.5
4.1
3.0 2.9
4.9
4.0
2.22.8
0.7
4.0
-0.8-0.4
1.01.5 1.5 1.7 1.9 2.1 2.1 2.2 2.4 2.6 2.7 2.9 2.9 2.7
-2%
0%
2%
4%
6%
8%
10%
Q1 06 Q2 06 Q3 06 Q4 06 Q1 07 Q2 07 Q3 07 Q4 07 Q1 08 Q2 08 Q3 08 Q4 08 Q1 09
GR
OS
S R
ET
UR
N P
ER
QU
AR
TE
R Quarterly Returns
Cash
Source: OMIGSA
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-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
TOP40 TR (monthly) Capital Builder (monthly)
Capital BuilderPerformance history since inception
Avg negative monthly returns Avg positive monthly returns
7.6% participation
41.7% participation
Attractive non-linear
pay-off profile
Note: Split determined by equity market performance (-ve or +ve)
Annualised Nominal Return
Return in Excess of Cash
TOP40 TR 5.3% -3.9%Capital Builder 11.7% 2.5%Cash 9.2% 0.0%
Out-performed both cash & equities
Participate more in equity upside, and less in equity downside
Source: OMIGSA
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EX
PE
CT
ED
R
ET
UR
NS
High
Low
Stable VolatileCONSISTENCY OF QUARTERLY RETURNS
RISK
RETURN
Cash
AbsoluteReturnFunds
VariableIncomeVariableIncome
CapitalBuilder
BalancedFunds
Capital BuilderTax efficiency
tax
tax
tax
tax
tax
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Capital BuilderExample of effective tax rate for individuals
COMPONENTS OF TOTAL RETURN
100% 40%19%
17%
64%
40%
0%
10%
1. Interest
2. Dividends
3. Capital Gains
Effective tax rate(ignoring tax deferral)
Applicabletax rate
EFFECTIVE TAX RATE ON CAPITAL BUILDER
Applicabletax rate
Proportion of total return
Proportion of total return
EFFECTIVE TAX RATE ON CASH DEPOSIT
100% 100%
40%14%
Source: OMIGSA
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Capital BuilderIllustration of returns net of fees and net of tax
Notes:1. Cash return + 2.5% pa (based on Capital Builder Institutional Fund returns from 1 Dec 05 to 28 Feb 08, and the Unit Trust class B returns
thereafter until 31 Mar 09)2. Cash returns from Standard Bank Call deposit 3. Fees calculated as 0.9% + (15% of benchmark outperformance) + VAT
11.7% pa1
9.2% pa2
Capital Builder Call deposit
40% taxedinvestor
Fees = 1.4%3
Tax = 3.7%(tax rate = 40%)
Tax = 1.4%(tax rate = 14.0%)
8.9% pa
5.5% pa
1.1%
untaxedinvestor
3.4%
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Capital BuilderSummary
Very low risk, stable returns
Aims for quarterly capital protection
Targets gross return of cash + 3%pa over 3 year rolling period
Tax efficient return compared to cash and money market
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Consistent returns are important to keep financial plans on track
Diversification alone does not protect capital
Cost-effective hedging of downside risk is available through selective use of put options
Money market investors should consider the enhanced returns and greater tax efficiency available from a protected equity solution
Capital protection is important
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Regulatory Information
Old Mutual Investment Group (South Africa) (Pty) Limited Physical Address: Mutualpark, Jan Smuts Drive, Pinelands, 7405 Telephone number: +27 21 509 5022
Old Mutual Investment Group (South Africa) (Pty) Limited is a licensed financial services provider, FSP 604, approved by the Registrar of Financial Services Providers (www.fsb.co.za) to provide intermediary services and advice in terms of the Financial Advisory and Intermediary Services Act 37 of 2002. Old Mutual Investment Group is a wholly owned subsidiary of Old Mutual (South Africa) Limited. Reg No 1993/003023/07.
The investment portfolios may be market-linked or policy based. Investors’ rights and obligations are set out in the relevant contracts. Market fluctuations and changes in rates of exchange or taxation may have an effect on the value, price or income of investments. Since the performance of financial markets fluctuates, an investor may not get back the full amount invested. Past performance is not necessarily a guide to future investment performance.
Personal trading by staff is restricted to ensure that there is no conflict of interest. All directors and those staff who are likely to have access to price sensitive and unpublished information in relation to the Old Mutual Group are further restricted in their dealings in Old Mutual shares.
All employees of Old Mutual Investment Group are remunerated with salaries and standard short-term and long-term incentives. No commission or incentives are paid by Old Mutual Investment Group to any persons. All inter-group transactions are done on an arms lengths basis.
In respect of pooled, life wrapped products, the underlying assets are owned by Old Mutual Life Assurance Company (South Africa) Limited who may elect to exercise any votes on these underlying assets independently of Old Mutual Investment Group. In respect of these products, no fees or charges will be deducted if the policy is terminated within the first 30 days. Returns on these products depend on the performance of the underlying assets.
Old Mutual Investment Group has comprehensive crime and professional indemnity insurance. For more detail, as well as for information on how to contact us and on how to access information please visit www.omigsa.com.
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