If this year has taught us anything, it is that we need to hope for the best, but plan for the worst. In financial planning, clients are advised to reassess their financial goals when faced with important life events and/or changes, such as getting married, having a child or with the loss of a loved one. This year, a significant event happened with the outbreak of COVID-19, impacting investors globally. As we approach the end of 2020 and the start of a new year, why not take the time to assess your current financial goals, whether these goals are still relevant, set new goals if needed and make sure you are set-up for success going into 2021.

As clients continue to deal with the stressors and worries caused by the pandemic, they may be having trouble making sound financial decisions. Research has shown that we all suffer from behavioural biases, and we can be even more prone to behavioural mistakes during times of uncertainty.

Uncovering your real goals

It is likely that 2020 has impacted investors livelihoods and financial circumstances, and thereby also their financial goals.

What are your top financial goals? As investors, we all face this question at some point, and we generally have an answer. But have you ever looked at how stable or consistent your answers are, when you think about them in different contexts or at different times? It may surprise you, but researchers have found that we tend to answer with whatever is top of mind, which may not always be our true, long-term goals.

For example, let’s say a friend recently read an article about vacation trips in Italy. When you ask about long-term goals, the response might be: “I’d like to travel more,” even though the person also cares deeply about leaving a legacy of charitable works. It’s not that the person is insincere or that other goals aren’t deeply held – it’s just that is what’s top of mind and easy to recall.

Tailoring your financial plan around your personal goals can both increase your total returns and motivate you to stay on track¹. The success of this technique however depends entirely on having the right goals in place – which research suggests we, as investors, struggle to identify.

To prompt more-thoughtful goal identification, past research suggests that a carefully curated list —a master list — of common objectives can be effective. Master lists have been shown to improve preference identification across a variety of areas. Our research tested the effectiveness of lists for identifying financial goals. We wanted the answer to the question: How can we help investors identify their true financial goals, and not only those that are top of mind?

We found that many people seemed to prioritise goals that were more personalised, detailed, and emotionally grounded after viewing the master list, and the use of a master list also seemed to nudge investors toward more-specific goals.

We found that about half of the people who changed their top goal focused on emotions instead of the outcome. Using a master list drew an important parallel between emotional returns and financial returns. Many people who changed their goals settled on outcomes that revolved around emotional security, such as “to feel secure about my finances now” and “to not be a financial burden to my family as I grow older”. While emotions are often seen as anathema to sound financial decisions, our results suggest that there’s a big emotional component to holistically defining financial goals.

If your goals changed, you’re not alone. At Morningstar, we created a worksheet to guide clients through the process of setting financial goals. Advisors can use this printable exercise to nudge clients toward deeper consideration of what goals are most important to them. This can prompt a meaningful discussion around goal setting and help people avoid top-of-mind, but superficial, goals. We also recommend that you read our research report “Mining for goals” to find out more about the research behind the worksheet.

Behavioural biases, that often creep in during the goal-setting process, surface when we are facing uncertainty — and when it comes to investment decisions, these biases can hurt more than they help. Investors may benefit from having a resource of their own from which to learn the impact of behavioural mistakes on their finances and how to avoid them. We created a checklist you can send to your clients to help them start to incorporate behavioural techniques into their financial decisions.

This checklist is written for investors, so you can offer clients a resource they can peruse on their own time as well as in your virtual check-ins. This way, you can both work together to help clients thoughtfully navigate their financial decisions and empower them to use behavioural techniques on their own when they may need them the most.

Investors are facing quite a few obstacles when it comes to making thoughtful financial decisions. We can’t erase the emotions and biases that come with these unprecedented times, but effective planning and practicing some behavioural techniques can help investors prevent these factors from getting in the way of their long-term financial goals.

This is where advisors can turn to lessons from behavioural science to help keep investors on track. We’ve created a guide and checklist for advisors to explore how to use these behavioural techniques in their practice.

Understanding your financial goals is central to financial planning but identifying goals that truly matter can be tough. Now, more than ever, we must take the time to avoid behavioural biases, establish strong financial goals, and implement behaviours to help meet these goals.

1 – Blanchett 2015; Locke et al. 1990).

Victoria Reuvers

Managing Director

Morningstar Investment Management South Africa

Risk Warnings
This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.
This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.
Morningstar Investment Management South Africa Disclosure
The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.
+ t: (0)21 201 4645 + e: MIMSouthAfrica@morningstar.com + 5th Floor, 20 Vineyard Road, Claremont, 7708.

The importance of good saving habits

As we emerge from the stringent lockdown restrictions of the past 100 plus days, many of us are now facing a world that looks quite different from what we were used to merely months ago. For many of us, things have changed drastically, especially financially. With July being “National Savings Month” in South Africa, it is perhaps time to pause and dwell a bit on the topic of savings.

Countless individuals have been faced with and/or might still face retrenchment, having to take unpaid leave, drastic salary cuts or the possibility of losing their business. This reality hits home hard. Due to the unforeseen and devastating aftermath of the Covid-19 pandemic, many individuals have been forced to tap into their savings. The current circumstances have made people acutely aware of how important it is to have an emergency fund and/or contingency plan.

With this in mind, let’s unpack the famous words of the well-known investor, Howard Marks: “you can’t predict but you can prepare”.

Prediction is a fool’s game

The first point to highlight is that trying to predict the market is fool’s game, however, it is human nature to try to find comfort in some sort of prediction of an outcome. This is because humans like to think they know what is going to happen next.

Using a very simple mathematical example, the below equation illustrates how the odds are against you when trying to predict an outcome. Firstly, you have to predict the event correctly, and secondly, you have to predict how the market will react as a result of the event. If you don’t get both right you won’t be able to capitalize on the opportunity. Let’s say you are exceptionally good at predicting and you get it right 70% of the time, the odds are still the same as flipping a coin.

Probability of predicting the event correctly x Probability of predicting the market’s reaction correctly

= 70% * 70%

= 49% (same odds as flipping a coin)

The table below details two examples of recent events that an investor could have predicted accurately, but most people got the second prediction – how the markets will react – wrong.

As we reflect on the events of the past couple of months, one thing is certain: it was impossible to predict the events that have unfolded this year and the resulted reaction of markets, governments and economies.

The only thing we can do is to do our best to prepare for times like these.

Preparing for the unknown

In a world filled with randomness and uncertainty a far better strategy than to prepare for the unknown is to focus on the known. What is known is that there are three primary drivers of results in life:

1) Your luck (randomness).

2) Your strategy (choices).

3) Your actions (habits).

Only two of these three drivers are within your control – your strategy and your actions. By focusing your efforts on your choices and habits, you take ownership of your finances, instead of leaving it up to chance.

The best way to prepare for these unknown and unprecedented times is to build up a nest egg. The most obvious way of doing this is by saving and taking advantage of the power of compounding.

In the words of Warren Buffett – “Do not save what is left after spending but spend what is left after saving”. Unfortunately, many investors tend to spend first and save what is left. Often these investors also make the mistake of not saving the little that is left, as they believe it won’t make a difference.

In January 2020, Victoria Reuvers, managing director of Morningstar Investment Management South Africa wrote an article in which she shows that anyone has the ability to become a millionaire. What it requires are two simple, but not easy, habits – firstly, start and stick to the habit of saving and secondly, be patient. Most investors’ path to becoming a millionaire is not by investing in the next big thing and making a quick buck overnight. For most of us, it is about building good habits and being disciplined when it comes to saving – even if it is just R200 a month.

We encourage investors to use July as an opportunity to re-think their budget, savings and spending habits and encourage their children to practice good habits from a young age. Think about a good savings habit like brushing your teeth. Twice a day for two minutes is all it takes, and although it may not feel like a big action at the time, the long-term positive effects are enormous. The problem when you don’t do it is that you only see the damage your poor habits have caused after a long period of time.

Some practical ideas to start saving

In South Africa, you can save R36,000 per annum in a tax-free savings account, and a maximum of R500,000 over a lifetime. This is probably the easiest vehicle to ensure you get the benefit of investment returns without the concern of a tax bill at the end of the financial year. Another effortless way to save is to set up a monthly debit order to an investment account. Not only do you then save first and spend after saving, but you also have the option to increase this amount annually and/or make lump sum contributions as well.

Other tips to start saving money every month:

• Assess what you are paying in bank charges and if you are using all the additional services. You can perhaps switch to a cheaper offering.
• Contact your insurance provider to re-negotiate your monthly premium.
• Cancel any memberships that you don’t use.
• To save electricity consider replacing all your lightbulbs in the house with energy-efficient ones and use gas appliances where possible.
• Reduce discretionary spend: Try to buy clothes, furniture, appliances and other discretionary items only when they go on sale and don’t buy these items on credit.
• Buying groceries in bulk can greatly reduce your grocery bill.
• When going on holiday, shop around for special deals on flights and accommodation and search for discount coupons in the area that you are visiting.

These are just a few examples and there are many more ways to save a couple of Rand every month. Don’t ever think that it is too little to have an impact. There is a lot of power in compounding value.

Conclusion

In unusual times like these, investors might feel vulnerable and powerless. But it is often during times like these that we should try to form new healthy habits and leave behind bad habits. Let’s try to kick the practice of trying to predict everything and kickstart the habit of saving, even if only in small increments.

Debra Slabber, CFA®

Business Development Manager

Morningstar Investment Management South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

On 26 February 2020, Finance Minister Tito Mboweni delivered the annual budget speech, providing an update on South Africa’s finances. Despite the budget speech highlighting the fragile state of the country’s fiscal position, the finance minister announced some much-needed relief for South African citizens. There were no major tax increases on individuals, while ambitious plans were announced to reduce expenditure over the next three years.

A high-level summary of the key points from the budget speech has been included below:

KEY TAKE OUTS

Revenue and deficits

• Low growth has led to an R63 billion downward revision to estimates of tax revenue in 2019/2020 relative to the 2019 budget.
• The consolidated budget deficit is now estimated to be 6.3% for the 2019/20 fiscal year and move lower to 5.7% for the 2022/23 fiscal year, with debt to GDP expected to rise to 72% over this period.

Taking a look at tax

• There will be above-inflation increases in the personal income tax brackets and rebates (for the first time since 2014) which will provide relief to taxpayers.
• There will be no changes to the tax-free portion of interest income (R23,800 for under 65’s and R34,500 for over 65’s).
• The annual limit for investments in tax-free savings accounts will be increased to R36,000 and the lifetime limit will be kept unchanged at R500,000.
• There will be no change to the corporate income tax or VAT rates, however, the minister announced that the corporate tax system will be restructured over the medium term, with the rate likely to be reduced.
• The cap on the exemption of foreign remuneration earned by South African tax residents will be increased to R1.25 million from 1 March 2020.
• In terms of capital gains tax (CGT), the inclusion rate remains at 40%, the annual exclusion remains at R40,000 and the exclusion for the sale of a primary residence remains at R2 million.
• In terms of transfer duty on property, the purchase amount free of transfer duty increases to R1 million.
• The deductible monthly medical aid contributions were increased to R319 for the first two members and R215 for each additional dependent.

Expenditure

• National Treasury announced plans to reduce expenditure by R261 billion over the next three years, including a reduction in the wage bill of national and provincial departments and national public entities of R160 billion.

Levies, duties and charges

• The fuel levy will be increased by 25c per litre, which will consist of a 16c per litre increase in the general fuel levy and a 9c per litre increase in the RAF levy.
• Excise duties on alcohol and tobacco will increase by between 4.4% and 7.5%. Government will also introduce a new excise duty on heated tobacco products, which will be at 75% of the cigarette excise rate.

State initiatives

• Government will move ahead with plans for a sovereign wealth fund, which will initially have a targeted capital amount of R30 billion.
• The establishment of a state-owned bank will involve the amalgamation of existing state-owned banks, including Postbank, with the aim of lending money to lower-income consumers and small businesses at favourable interest rates and terms.

In closing

Overall, the budget speech was well received by market participants, with both the rand and local bond yields reacting favourably on the day. The budget was largely pro-consumer, with no additional taxes being announced for individuals. In a surprise move, above-inflation increases in the tax brackets for individuals were also announced for the first time since 2014. The business sector will most likely welcome the state’s plans to restructure the corporate tax system over the medium term.

The most ambitious element of the budget speech was no doubt the plan to reduce the public sector wage bill by R160 billion over the next three years. With expenditure on public sector wages currently making up 35% of total expenditure, implementation of this reduction will be key.

Michael Kruger

Investment Analyst

Morningstar Investment Management South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.
This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

The current challenge facing many long-term investors is to simply survive the shorter-term market disappointments to benefit from the return premium offered by growth assets over the longer term.

For many investors, the last five years have been traumatic. Domestic woes and instability in global markets have resulted in muted returns across almost all asset classes.

Figure 1: A range of factors have led to disappointing returns

Source: Investec Asset Management.

While global assets have outperformed local assets, this outperformance is mostly due to rand depreciation, as evidenced in Figure 2. Over the five years to the end of October 2019, the rand has depreciated by as much as 7% per annum against the US dollar, thereby making up the bulk of the rand return for global cash and bonds and more than half the return for global equities.

Figure 2: Five-year annualised returns in rands to 31 October 2019

Market returns have proven a significant challenge for people drawing an income

A lack of retirement savings and depressed investment markets have left many pensioners anxious about the future. Jaco van Tonder, Advisor Services Director, has explored the challenges facing retirees as part of Investec Asset Management’s in-house research study into “How investors should approach living annuities”.¹

Jaco makes the point that even though the principle of “beating inflation requires exposure to equities” is widely accepted by investment professionals, it is easy to overlook this principle in situations where an investment portfolio is required to produce an income. Jaco also makes two conclusions that are relevant to this article:

1. Living annuities require meaningful equity exposures to enable the annuity’s income levels to keep pace with inflation.
2. Fixed income portfolios are unable, on their own, to produce the returns required to keep pace with inflation.

Investing in the wrong asset class is costly in the long term

Despondent investors have increasingly sought refuge in fixed income investments, thereby potentially compromising their long-term investment goals. This behavior is even true for conservative investors who had previously invested in multi-asset low equity funds (i.e. lower risk funds that target inflation beating returns over rolling three-plus years), such as the Investec Cautious Managed Fund.

For long-term investors, however, investing in the wrong asset class can prove costly. The South African Savings Institute (SASI) makes the point that while in the short-term cash and bonds may be somewhat safer, in the longer term they provide less protection against inflation and therefore are unlikely to maintain real buying power.

1 – A new approach to living annuities: https://www.investecassetmanagement.com/south-africa/professional-investor/en-za/insight/living-annuity-an-active-solution/.

Furthermore, tax considerations generally accentuate this outcome. SASI’s analysis suggests that over time, the four domestic asset classes are likely to produce the following real (after inflation) returns in the long run:²

• Cash: 0 to 1%

• Bonds: 1 to 3%

• Property: 2 to 4%

• Equities: 7 to 9%

It is also important to note that with inflation well within the target range and developed market interest rates at all-time lows, interest rates in South Africa are likely to trend downwards. The attractive real returns offered by money market and other flexible fixed income investments are therefore likely to come under pressure as a result. At the same time, we are now far more optimistic on the prospects for growth assets to deliver inflation-beating returns in the future.

Targeting consistent real returns to conservatively grow your savings

We therefore continue to argue that conservative investors should reconsider the important role that multi-asset low equity funds can play in their portfolio. These funds offer a bias to income-generating assets, while maintaining a growth element.

The Investec Cautious Managed Fund, for example, is suitable for conservative investors saving for retirement and for retirees drawing an income from a living annuity. The fund is well-positioned to meet these needs, thanks to its broad investment opportunity set that allows for investment in assets that offer growth and income, and a strong emphasis on capital preservation. As a result, the Investec Cautious Managed Fund has delivered a positive real return over rolling three-year periods 80% of the time, as shown in Figure 3.

Figure 3: Growing investor capital in real terms

A key strength of the fund is its ability to exploit the changing investment opportunity set. Historically, multi-asset funds have looked to South African equities as the primary driver of real returns and offshore bonds as the uncorrelated defensive asset. However, we believe that offshore equities are now the best opportunity for growth, with South African bonds offering attractive risk-adjusted returns, as well as helping to counterbalance risk in the portfolio.

This view is reflected in the next two charts. Figure 4 shows the changing asset allocation of the Investec Cautious Managed Fund over time, while Figure 5 depicts the Quality capability’s range of expected returns over the next five years from the different assets held in our Quality portfolios, including the Investec Cautious Managed Fund.

Figure 4: Investec Cautious Managed Fund asset allocation since 2006

Figure 5: Range of expected annualised returns for current Investec Cautious Managed Fund holdings (in rands)

In conclusion

In today’s uncertain investment environment, asset allocation and stock selection are key. Conservative investors should consider entrusting a portion of their investments to the experienced, well-resourced and globally integrated portfolio management team who manages the Investec Cautious Managed Fund. To quote, Duane Cable, Investec Cautious Managed Fund Portfolio Manager: “In the volatile world in which we find ourselves, it has become increasingly apparent that one needs to have a global perspective to navigate the choppy waters of investment markets”.

Important information

All information provided is product related and is 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 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, Investec 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 Total Expense Ratio (TER). A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The ratio does not include transaction costs. The TER of the Investec Cautious Managed Fund (A) class is 1.73%. The current TER cannot be regarded as an indication of the future TERs. Additional information on the funds may be obtained, free of charge, at www.investecassetmanagement.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. Investec Asset Management (Pty) Ltd (“Investec”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA). This document is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Investec Asset Management (Pty) Ltd is an authorised financial services provider. Issued, December 2019.

What are ASISA’s views on prescription of assets and why?

When the term “prescribed assets” is used, it is understood to refer to Government forcing the savings industry to buy Government stock as well as bonds issued by State Owned Enterprises (SOEs) on behalf of investors like retirement funds. This concept was first introduced by the previous Apartheid government and has been raised periodically over the years by various political parties.

It did not work when introduced by the Apartheid government and ASISA and its members maintain that it would have negative effects on the country should it be introduced now.

The savings and investment industry, as represented by ASISA, has engaged extensively with various relevant parties on the potential impact of “prescribed assets”, including directly with Government Ministers tasked with infrastructure development, via Business Unity South Africa (BUSA) into the National Economic Development and Labour Council (Nedlac), and via the CEO initiative.

The Government under President Ramaphosa has been very collaborative as evidenced by the various engagements like the Jobs Summit, Investment Summit and the ongoing engagements with the CEO initiative. If “prescribed assets” are again tabled for discussion by Government, we believe engagements with our industry will be equally constructive.

ASISA is empowered by a mandate from members that manage some R6.2 trillion of the nation’s savings and investments and is therefore recognised as a significant and relevant partner around Government’s negotiation table. We regularly engage on a number of issues regarding policy, regulatory reform and other issues of national priority such as economic transformation and inclusion.

Why do we oppose “prescribed assets”?

• The concept of “prescribed assets” would force the savings and investment industry to deploy the savings of ordinary South Africans into entities that have over the recent past been mired in State Capture and lack of delivery. As custodians of these savings we have to oppose this.

• Asset managers are not asset owners. The bulk of the assets that could be prescribed are owned by retirement fund members. It also needs to be noted that roughly half of these assets are held by the GEPF and are therefore owned by public servants. As the owners of these assets, ordinary South Africans elect and appoint trustees to make asset allocation decisions that are in their best interest. Prescription would jeopardise this fiduciary duty.
• Prescription of assets interferes with the capital allocation function of the capital markets, which should always be objective and driven by performance. Forcing the market to invest in low yielding and/or high risk projects could have two direct consequences:

 – The incentive for these projects to compete would be removed as funding would no longer be incentivised by performance.

– Given that capital is a finite resource, deserving projects could be deprived of funding. These projects that would otherwise have driven growth and created sustainable employment would now not happen anymore.

• Prescription would have a negative impact on the country’s credit rating. If South Africa loses its investment grade rating, foreign investors, many of whom are pension funds, would be forced to withdraw their money from South Africa. This is something the country can ill afford.

Working with Government on infrastructure finance

ASISA has always maintained that the problem is not the lack of willingness of capital markets to invest, but rather the absence of viable projects. We are engaging with Government to address this with urgency.

ASISA and its members believe that many of our country’s challenges can be overcome through effective public private partnerships (PPPs).

ASISA was therefore represented by several of its Board members as well as senior policy advisers at President Cyril Ramaphosa’s Investment Conference last year, which took place under the theme “Accelerating Growth by Building Partnerships”.

ASISA is actively involved in working with Government on infrastructure finance for water, energy and student accommodation. We are also looking at collaborative delivery mechanisms with Government and the Development Bank of Southern Africa (DBSA) for programmatic financing solutions.

ASISA members have already deployed more than R1.3 trillion in support of Government, Local Authorities and State Owned Companies.

In addition, our industry has made direct investments of R200 billion into the following projects:

• Renewable energy
• Township development
• Affordable housing
• Urban regeneration
• Student accommodation
• Water
• Roads
• Agriculture (emerging farmers)

The short answer to the question above is that a downgrade would lead to it being more expensive for the South African government to borrow money.

Let’s first look at what it means to be downgraded. Think of it as a credit score from your bank manager – the less likely you are to default on your debt repayment, the better your score will be, whereas a weak score would indicate that you are more likely to default, and not be able to repay your debt.

When you have a bad credit score and you are seen as someone that could potentially not repay a loan, the establishment extending the credit to you assumes more risk in lending the money to you (as opposed to someone with a good credit score). Therefore, the credit provider will charge you a more expensive rate in order to be compensated for the increased level of risk it assumes in lending you the money. In the same manner, South Africa is rated on its ability to repay its debt and charged more when it has a bad credit rating.

So, what would the implications of a downgrade be for South Africa?

The rand could weaken against the US dollar due to foreigners selling local bonds. A sub-investment grade rating by all three major rating agencies would result in South African government bonds being removed from some major world bond indices such as the World Government Bond Index (WGBI). This could translate to a forced selling of South African bonds by international investors that are mandated to only hold investment-grade credit. In other words, certain investors would have to sell S.A. bonds as they won’t be allowed to hold such an investment.

Over the past decade, foreigners have bought a lot of government bonds and at the peak, they owned close to 40% of our bond market. However, of late, they have been selling our bonds and this number is now closer to 30%, which is still meaningful.

Whilst market pricing would suggest that these risks are priced into S.A. bonds (given that they are offering investors a real yield of close to 4%), it is possible that we could see yields creeping higher on the day of the downgrade, along with a weaker rand. Remember, if bond yields rise, it results in capital losses for bond holders. With that said, rising yields could also create buying opportunities for investors. Times of panic and stress often present golden opportunities to enhance returns if one can price risk appropriately.

If history is the best teacher, what have we learnt?

Like South Africa, Brazil has also suffered from political uncertainty over the last couple of years. Midway into 2015 Standard & Poor’s (S&P) changed the status of Brazil’s sovereign credit rating outlook to negative. The change in the outlook (not an actual downgrade) led to the demand for the government’s ten-year bonds dropping. This is similar to the conditions that South Africa is currently faced with.

Upon the news of Brazil’s outlook change, yields went from 12% to exceeding 16%. The currency followed suit and depreciated by roughly the same amount against the US dollar in approximately the same period – all without the country being downgraded.

Expectations were paved and the market priced in (the more than likely possibility of) a downgrade. In September 2015, as predicted, Brazil took the plunge from investment grade to junk status (a move from BBB- to BB+ in Standard & Poor terms).

It is interesting to note that both the currency and the yields started to strengthen/contract as if the market had predicted the worst-case scenario, priced the risk accordingly, and then pro-actively managed this risk before it even came to fruition.

It would seem, at the moment, that the global market has taken the same stance with South Africa and is virtually pricing in the worst-case scenario (before the actual event has occurred). As illustrated in the graph below, South Africa is currently one of the few countries globally to offer healthy real yields (this is after taking inflation into account) but is still required to pay more than countries such as Brazil and Mexico, both of which are already rated at sub investment grade.

Despite all the noise and concern the possibility of a downgrade has created, Morningstar continues to monitor developments and follow a rigorous valuation driven approach with the aim of building well-diversified portfolios that will meet end investors investment goals over reasonable time frames.

In an environment where inflation is around 4.5% and S.A. government bonds are yielding close to 8.8%, we believe the real yield of over 4% is an attractive investment. In addition to this, government bonds provide portfolio protection against a strengthening rand. While the rand has weakened dramatically over the past few months, we believe it is now looking slightly oversold.

Bringing this together, we believe the market conditions are challenging although not incomprehensible. Achieving positive portfolio outcomes continues to be our long-term focus, which is driven by a willingness to be different from others and in applying a disciplined investment approach.

Eugene Visagie

Portfolio Specialist, Morningstar Investment Management South Africa

Risk Warnings

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management South Africa (Pty) Ltd makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this commentary. Except as otherwise required by law, Morningstar Investment Management South Africa (Pty) Ltd shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

This document may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Morningstar Investment Management South Africa Disclosure

The Morningstar Investment Management group comprises Morningstar Inc.’s registered entities worldwide, including South Africa. Morningstar Investment Management South Africa (Pty) Ltd is an authorised financial services provider (FSP 45679) regulated by the Financial Sector Conduct Authority and is the entity providing the advisory/discretionary management services.

What Investors Think, What Advisors Think, and How Everyone Can Get on the Same Page

Disconnected Expectations

Advisors can provide value to clients in many ways, from goal setting to tax planning to behavioral coaching. But how do clients perceive the value of these services?

Our research suggests that there’s a difference between what investors value from their advisors and what advisors believe investors value, and that disconnect creates problems on both sides of the relationship. For advisors, it’s hard to build a mutually beneficial relationship if clients don’t understand the value of the advice they’re getting. And it . can be frustrating for clients if it seems that their advisor isn’t meeting their expectations.

While our results show that expectations around advice aren’t always aligned, this gap can be bridged by understanding where the differences are and where the value lies in client/advisor relationships.

Measuring the Value of Advice

The industry consensus on why financial advice is valuable is different than it used to be. While an advisor’s worth used to be simply based on the advisor’s ability to beat a benchmark, it’s now understood that an advisor’s value is far better measured by the impact that their services can have on investors’ financial outcomes. New metrics and research findings show that the interpersonal aspect of advice may have more impact on a person’s finances than anything else. This outlook favors services like behavioral coaching—helping clients mitigate their biases and stay the course—and personalized advice versus traditional selling points like maximizing returns and asset allocation.

Gamma¹, a metric introduced by Morningstar’s David Blanchett and Paul Kaplan, measures the additional expected retirement income achieved through wise financial-planning decisions, and many of these decisions are made with an advisor’s assistance. Morningstar’s Gamma research demonstrates that making sound financial planning decisions in five areas—asset allocation, withdrawal strategy, guaranteed income products, tax-efficient allocation, and portfolio optimization— can generate 29% more income on average for a retiree.

Vanguard’s Advisor’s Alpha² is similar. It measures the value added, in basis points, by seven best practices in wealth management: asset allocation, cost-effective implementation, rebalancing, behavioral coaching, asset allocation, spending strategy, and total-return investing versus income investing. This research suggests that behavioral coaching is the single most impactful thing an advisor can do, adding, on average, 150 basis points. As investors, emotions can be our own worst enemy, especially when the markets are volatile, and guidance from a behavioral coach can save us from panic selling and abandoning long-term financial plans.

Additional Morningstar research³ found that offering clients personalized advice and using a combination of interventions—like increasing someone’s contribution rate to 6% and retirement age to 67—can help 71.2% of households avoid extreme austerity and still have what they need when they retire. These findings aren’t outliers: Numerous studies demonstrate that advisors can have a huge impact on investor finances, but it’s hard to say if these findings have been recognized and understood by everyday investors.

1 – Blanchett, David, and Kaplan, Paul. “Alpha, Beta, and Now…Gamma.” The Journal of Retirement 1, no. 2 (Oct. 31, 2013): 29–45.
2 – Kinniry, Francis M., Jaconetti, Colleen M., DiJoseph, Michael A., and Zilbering, Yan. “Putting a Value on Your Value: Quantifying Vanguard Advisor’s Alpha.” The Vanguard Group, 2014.
3 – Wendel, Steve. “Easing the Retirement Crisis.” Morningstar, 2018.

Defining Advisor Value

Our study examined investor perspectives on the value of working with a financial advisor and how that compared with what advisors thought investors value about working with financial advisors. In our survey, 693 individual investors ranked a set of common attributes (see Exhibit 1) in order of importance. We also surveyed advisors about these attributes; 161 responded, ranking the attributes in the order they thought investors found most valuable.

Exhibit 1: List of attributes

1. Helps me stay in control of my emotions
2. Has a good reputation and positive reviews
3. Is knowledgeable on tax consequences of investing
4. Can help me maximize my returns
5. Is approachable and easy to talk to
6. Helps me reach my financial goals
7. Is easy to get a hold of
8. Has a clear fee structure so I know what I’m paying for
9. Understands me and my unique needs
10. Uses up-to-date technology
11. Acts as a coach/mentor to keep me on track
12. Presents themselves in a professional manner
13. Keeps my interests in focus with unbiased advice
14. Communicates and explains financial concepts well
15. Has the relevant skills and knowledge

Source: Morningstar.

Room for Improvement

After comparing the average ranking of each attribute between advisors and investors, we found some agreement between both groups on what attributes are important and valuable, but not strong agreement. The correlation⁴ between both groups’ average lists is about 0.46—meaning there is a moderate relationship between the two lists. There are interesting disagreements on what’s considered valuable, and this suggests that there are opportunities for advisors to better address investors’ needs and educate investors on the real value of advice.

How Did the Goals Change?

Advisors and investors both place “Helps me reach my financial goals” in their top three most valuable attributes, but the other top attributes display different priorities. Investors valued the technical side of financial advice more than other benefits of advice—especially in the behavioral realm. “Helps me stay in control of my emotions,” for example, is ranked last by investors even though research suggests that cognitive biases and other behavioral obstacles often inhibit investors from making sound financial decisions, especially when their emotions are running high.⁵ Behavioral coaching is one solution for common behavioral mistakes (such as panic selling in a market downturn) but it was all but ignored by the investors who took our survey. Given the numerous research findings suggesting that behavioral coaching is the single most impactful service an advisor can offer, there’s obviously an opportunity for communication and education here.

Advisors Emphasize Personalization

Investors in our survey said maximizing returns was a key part of the value of advice, while advisors said they thought investors valued personalization and portfolios tailored to their unique needs. Advisors’ emphasis on personalization lines up with research that advocates for new approaches to investing, such as goals-based investing, which can result in 15% more client wealth.⁶ Even though personalization or behavioral coaching may result in more overall wealth, our research suggests that investors do not see their value. This shouldn’t surprise anyone. For years, professional financial advice was promoted as a way to beat the market, and while financial and investing professionals might understand that this isn’t the case, changing the “returns first” perception won’t happen overnight.

Communicating True Value

It’s not enough for financial professionals to understand the value of advice beyond investment selection—investors must understand it as well. And advisors have a prime opportunity to educate their clients, show them the value of a broader, goals-based approach to investing, and build long-term trust that doesn’t fall apart when the market swings. Here’s an example of how that could work: An investor is three years away from retirement and on track to meet her goals, but she’s still focused on maximizing returns. A goals-based approach can help the advisor explain the trade-off inherent in maximizing returns, specifically the possibility of added risk that could prevent her from reaching her financial goals. With proper communication, the advisor can help that client understand why a goals-based approach that reallocates her funds to low-risk investments is the better option in her specific situation, since it can increase her chances of success.

5 – We tested variations on the wording of this attribute and got similar results, which suggests that the idea, not the wording, was what didn’t resonate with individual investors.
6 – Blanchett, David. “The Value of Goals-Based Financial Planning.” Journal of Financial Planning 28, no. 6 (2015).

What This Means for the Industry

It’s easy to look at our results and think that investors are just behind the times, but in many ways their responses show that investors have internalized the industry’s past tendency to over-emphasize returns and benchmark relative performance. Research shows that the interpersonal side of advice, which includes personalization and behavioral coaching, can be the most valuable aspect of professional advice, and the industry needs to better articulate that. Returns aren’t the end-all, be-all—modern advice is more coaching than stock-picking, and the short-term returns are only part of the picture.

Changing investor perceptions won’t be easy, but it’s a challenge worth taking, both for investor success and the success of professional advisors.

About Samantha Lamas

Samantha Lamas is an associate behavioral researcher at Morningstar. She focuses on developing content and conducting research to better understand who investors are and how we can help them reach their financial goals. She began her career at Morningstar as a product consultant working directly with the individual investor and advisor audience segments. Samantha holds a bachelor’s degree in business with a concentration in finance from Dominican University.

About Ryan O. Murphy, Ph.D.

Ryan O. Murphy, Ph.D., is head of decision sciences for Morningstar Investment Management and part of the behavioral insights team. Murphy’s research is interdisciplinary, bringing together methods from experimental economics, cognitive psychology, and mathematical modeling to understand how people make decisions and develop ways to improve decision-making. Before joining Morningstar in 2016, he was the chair of decision theory and behavioral game theory at the Federal Institute of Technology in Zurich, Switzerland, and a visiting professor in the University of Zurich economics department. Previously, he served as associate director of the Center for the Decision Sciences at Columbia University in New York. Murphy has written extensively about human decision-making and has been published in Management Science; Experimental Economics; Decision; Judgment and Decision Making; Personality and Social Psychology Review; and the Journal of Behavioral and Experimental Finance. He’s taught university courses in decision theory, behavioral economics, negotiation analysis, experimental game theory, and statistics.

About Ray Sin, Ph.D.

Ray Sin is a behavioral scientist at Morningstar. His research draws from psychology, economics, and sociology to better understand investor behavior. His goal is to leverage data, guided by social science theories, to generate and experimentally test interventions that help improve investors’ success by avoiding common behavioral obstacles. To that end, he has developed subject-matter expertise in two areas: (a) sustainability, aiming to learn how investors think about environmental, social, and governance factors when they invest; and (b) the relationship between financial and non-financial goals, understanding if the pursuit of non-financial goals may lead to positive financial outcomes. Recently, he, together with others, completed an experiment with a nationally representative sample on fee sensitivity and perception of fees. Ray holds a bachelor’s degree in sociology from National University of Singapore, and received his Ph.D., also in sociology, from the University of Illinois at Chicago.

Are you investing enough for your future?

A key question that needs to be answered in any financial planning exercise is “How much do I need to save so that I can comfortably maintain my standard of living in retirement?” Addressing this correctly and timeously is critical as pensioners have different needs (a regular income that ideally increases with inflation over time) and different risks (running out of money i.e. living too long) to other types of investors. There are also important psychological aspects that must be considered, given that it is unlikely that retirees will be able to live on the state older person’s grant (previously the state old age pension), go back to work or want to be supported by their family.

Investec Asset Management recently completed an in-depth study into how investors should approach their retirement income provision. One conclusion highlights that choosing the right level of starting income is key to investors managing their risk of running out of money. In short, a retiree should elect a starting income level of no more than 5% of their retirement capital.1 (Other conclusions highlight the value of active management and the impact of volatility on income, and the importance of growth assets for income.)

Five and twenty are the numbers to remember

With this starting income level of 5% of retirement capital as your standard, we are able to calculate that you require a capital lump sum equal to 20 times your final salary to invest in an income-producing annuity on retirement. This is the amount required to generate an income equal to 100% of your final salary, post retirement (i.e. a replacement ratio equivalent of 100%). Drawing no more than 5% is considered likely to provide you with an inflation-adjusted income for 30 years, ensuring a comfortable retirement. Any capital lump sum of less than 20 times will result in a lower starting income (a lower replacement ratio) than your final salary and therefore you would need to reduce your monthly expenditure accordingly.

Start early – but remember it is never too late

While knowing how much you require is critical, so too is knowing where you are on the path to this lump sum. Arriving at a sufficient retirement pot is a journey that takes a full working lifetime, as the following formulas illustrate. The impact of delay is considerable:

Starting at working age 20

15% of pre-tax salary x 40 years of employment = 20 times income required at age 60

In this example, someone starts working at age 20 and saves 15% of their pre-tax salary every month

for their entire working career. And, in the event they change jobs, they preserve their existing

retirement savings. This proverbial unicorn is one of the minority who can retire comfortably

at age 60.

Starting 10 years later

30% of pre-tax salary x 30 years of employment = 20 times income required at age 60

A more realistic example is where someone does not start providing for their retirement from age 20

or does not preserve their retirement benefits when they change jobs in the first 10 years. They are

then required to save twice as much of their pre-tax salary for the shorter 30-year period to achieve

the same outcome (or retire at 70).

Starting 20 years later

60% of pre-tax salary x 20 years of employment = 20 times income required at age 60

The more extreme outcome of the example above requires an improbable savings rate of 60% of

pre-tax salary (or retirement at 80!).

Clearly, there are no quick fixes to a lack of retirement provision and, for many, very little likelihood of being able to comfortably retire at 60 unless you act wisely at the right time. However, it is never too late to start.

How do you know if you are on the right path?

Now that we have established how much you need at retirement and therefore what percentage of your salary you should be saving monthly, how can you assess your progress along the way? The following chart shows you what multiple of your current annual salary you need to have saved at any age between 20 and 60 to ensure a replacement ratio equal to 100%. We have also shown the multiples required for a 75% replacement ratio by way of comparison. A 75% replacement ratio may suffice for many retirees, depending on their lifestyle choices and financial obligations. Once retired, retirees do not typically contribute to a retirement fund anymore. Transport and clothing costs could come down, and they may be debt free, with financially independent children.

So, by age 40, you should have accumulated retirement savings of approximately 5 times your annual salary if you are targeting a replacement ratio of 100%. Another interesting observation of this chart is the acceleration of capital values in later years, a clear illustration of compounding benefits. Note, while it took 20 years to accumulate savings of 5 times your salary it takes only a further 10 years for your accumulated savings to double to 10 times, and then only another 10 years for your accumulated savings to double yet again and reach the magical 20 times! The value of active management should not be overlooked. A key assumption in our calculations is a portfolio return of 7% above inflation, which joins forces with compound interest and your contributions to deliver your lump sum available at retirement. With this return, 40 years of saving 15% of your pre-tax income should see you retire comfortably, drawing 5% per annum from your savings. However, if returns are 2% higher, at CPI + 9%, you’ll have saved 35 times your final salary.

What role can Investec Asset Management play?

 Given the importance of retirement provision, the best approach is to seek professional financial advice. As a dedicated active manager, Investec Asset Management offers a comprehensive range of local and offshore unit trust funds, certain of which have the strong growth engine bias that is required by investors saving for retirement. The Investec Opportunity Fund specifically targets inflation plus 6% per annum over rolling 3 to 5 years, and importantly no negative returns over rolling 24 months. Given the challenging investment environment, Portfolio Manager, Clyde Rossouw, emphasises the importance of maintaining a balance of exposures that offer protection in several different investment environments. “With risk at the fore and liquidity being drained away, we do not believe that it is appropriate to position the portfolio for a particular outcome.”

Author: PAUL HUTCHINSON – Sales Manager

1 Jaco van Tonder, Investec Asset Management: “A sensible income strategy is critical for living annuity investors”.
2 For more information, please see the following link to the dedicated “New approach to living annuities”
3 *Assumptions: 15% of pre-tax salary saved for 40 years; salary increases at CPI+1.5%; portfolio return (whilst saving for retirement) = CPI+7% p.a.

Important information

This Viewpoint details Investec Asset Management’s (Investec’s) research findings on income withdrawal strategies for income- generating portfolios. The information presented here is not intended to be relied upon as investment advice. Various assumptions were made. There is no guarantee that views and opinions expressed will be correct. The findings expressed here may not reflect the views of Investec as a whole, and different views may be expressed based on different investment objectives. Investec has prepared this communication based on internally developed data, public and third-party sources. Although we believe the information obtained from public and third-party sources to be reliable, we have not independently verified it, and we cannot guarantee its accuracy or completeness. Investec does not provide any financial advice. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Prospective investors should consult their financial advisors before making related investment decisions. All information is as at 30.10.18 unless stated otherwise. All information provided is product related, and is 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 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, Investec 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 Total Expense Ratio (TER). A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The ratio does not include transaction costs. The current TER cannot be regarded as an indication of the future TERs. Additional information on the funds may be obtained, free of charge, at www. investecassetmanagement.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. Investec Asset Management (Pty) Ltd (“Investec”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA).This is the copyright of Investec and its contents may not be re used without Investec’s prior permission. Investec Asset Management (Pty) Ltd is a member of the Association for Savings and Investment SA (ASISA). Investec Investment Management Services(Pty) Ltd and Investec Asset Management are authorised financial services providers. Issued, October 2018.