By: Isaack Veii
Global uncertainty has increased over the last 20 years or so, which means more than ever, global events impact investment markets.
Whether it be political influence, war, outbreak of a pandemic, disruption in trade or supply of goods, all these factors contribute towards market volatility.
What remains is the need to invest for retirement, grow above inflation and maintain one’s purchasing power.
So, what has changed? This forces us to rethink how we invest, by looking at options that offer protection while still seeking growth.
The reality is, that if we do not seek real investment growth, we stand a chance of losing the battle against inflation. This means that a N$100 today, will be of less value in the future.
So, what should investors do in these uncertain times? Should we ‘de-risk’ by moving to “safer assets” such as cash and bonds or should we wait until equity markets stabilise to invest again?
The simple answer is: “No!” When investing for retirement, one needs to spend time in the market rather than trying to time the market. Despite being surrounded by uncertainty, we need to maintain our exposure to growth or risky assets such as equities to beat inflation.
What does risk mean to you? Is risk the volatility of investment markets which means that your investment moves up and down in value? Is risk the possibility of not being able to meet a financial goal in the future? Or could risk be when you put N$100 under your mattress or in a piggy bank with the hope of saving for the future without growth?
Technically, all 3 should be defined as risk, which can be explained as follows: If you drop from N$100 to N$95, over time this investment will grow back to N$100 or even more.
This is called volatility, and although we cannot predict when these drops will occur, or how often it will occur, the result tends to be positive over time.
If you need to have N$1 million at retirement to retire comfortably and this target is not met, the risk would be that your future sustainability would be impacted.
This would force you to make lifestyle changes in the future based on lower-than-expected income in retirement. This risk would always remain but can be managed to a certain extent.
Lastly, if inflation is at 5% for the year, this simply means that from N$1,000 last year, you would need N$1,050 this year to be able buy the same goods.
So, if your money does not grow in line with or above inflation, that means you will not be able to afford the same goods in future. So, one of the biggest risks we can take, is by not taking on enough risk!
Rather than avoiding risk, it needs to be managed. And this is where solutions such as guaranteed or smoothed bonus funds become quite attractive.
These funds combine risky assets such as equities with conservative assets such as cash and bonds to create a portfolio which is effectively known as a balanced or multi-asset fund. However, Smoothed Bonus Funds go two steps further in protecting your money.
What is a Smoothed Bonus Fund?
Smoothed Bonus Funds (SBFs) are long-term investment portfolios that use smoothing to provide for stable, inflation-beating returns to investors over the longer term, while significantly reducing the volatility associated with market-linked investments such as balanced funds.
The underlying investment portfolio that SBFs invest in range from conservative to aggressive balanced funds.
These portfolios usually invest in both local and global investment markets as well as alternative assets, such as private equity, natural resources, infrastructure, and/or development finance, which meet Environmental, Social and Governance (ESG) related factors.
How does a Smoothed Bonus Fund work?
SBFs aim to provide the investor with smooth returns throughout the journey to retirement by catering for both growth and protection of capital. The investment returns targeted by SBFs usually range between 2% and 6% above inflation.
As the portfolio grows, excess returns flow into a Bonus Smoothing Reserve (BSR). These excess returns are used to top-up returns allocated to SBF investors when growth assets are recording low/negative returns.
This process is referred to as ‘smoothing.’ It ensures that investors experience consistent growth while their investments are protected from losses recorded during periods when markets crash. This provides investors with peace of mind.
Most SBFs also provide capital protection. This provides the investor with the assurance that his/her investment will not reduce by more than the guarantee that has been purchased.
For example, if an 80% capital guarantee is selected and N$1 000 is invested, the investor is guaranteed that the investment will not reduce to less than N$800.
Any growth allocated to the investor is also guaranteed in this manner. So, if a return of 10% is allocated to the investment of N$1 000 the investment value grows to N$1 100.
Even if markets crash, the investment is guaranteed at N$880 at that point. Should a 100% guarantee be selected, the investment of N$100 plus any growth is fully guaranteed.
An insurance premium, more commonly known as a ‘capital charge,’ is levied on the investor to cover the cost of the capital protection. The higher level of capital protection, the higher the capital charge will be.
Did you know that if you lose 20% on N$1 000 today which goes to N$800, you need growth of 25% to get back to the original N$1,000. How long do you believe it will take to recover these funds? What does it mean to you if a market crash occurs during the month of your resignation or retirement?
Who should invest in a Smoothed Bonus Fund?
SBFs are ideally suited for:
- Individuals contributing towards a pension or provident fund, who are uncomfortable with volatile market returns.
- Retirement fund members (in pension or provident funds) who are within three to five years of retirement and need to have their accumulated capital preserved by moving into funds with higher levels of capital guarantees.
- Individuals who have retired from a pension fund, provident fund, retirement annuity or preservation fund, which selects a living/flexible annuity to receive an income in retirement.
Isaack Veii is the head of distribution and retention, corporate segment at Old Mutual Namibia. The views expressed herein are his own.