Ultima Financial Planners - News

Follow this link to download the newsletter: Ultima Newsletter - June 2010

I trust that you won’t say something like this! Unfortunately, investors were caught off guard again by advancing investment markets.

A 30 October 2009 article in Beeld by Neville Brand-Jonker describes how investors scrambled out of money market funds during the third quarter of 2009. R91 billion moved from money market funds to mainly asset allocation funds. Brand-Jonker commented that it seemed as if investors didn’t know where to allocate funds and trusted fund managers to do the job for them. He said that fund managers voiced their disappointment that ordinary investors again largely missed the upswing in the market.

It all began seven months ago and continued through October 2009 - the All Share Index (ALSI) of the Johannesburg Securities Exchange advanced more than 37% from March until the end of September. Mr Jeremy Gardiner form Investec Asset Management said that South African investors, just like their emerging market counterparts, didn’t trust the early upswing in the market. But why should they? Experts believed that the market would advance by 15% and then retrace. Unfortunately for investors, this did not happen.

We at Ultima have always believed that success as an investor is not achieved by the timing of markets. Rather, success comes through having a robust investment strategy and a correctly aligned asset allocation that’s closely monitored. Success over time will then be inevitable

Given their natural talent for their respective fields, what can the likes of Ryk Neethling, Tiger Woods, Lance Armstrong and the Williams sisters learn from someone else? These internationally-renowned sportspeople are dedicated, determined and confident. So why would they require a coach?

Behind virtually every champion athlete is a champion coach providing guidance in three key areas: improving technique, setting short and long-term goals and continually reigniting the athlete’s motivation to stay on track to achieve these goals. A financial coach or what we refer to as a financial planner, plays much the same role for champion investors.

setting short- and long-term goals

Ask any successful athlete, in fact, ask anyone who is successful in any particular field and the importance of goal setting will be immediately obvious. A coach working with an athlete for the first time will not immediately consider diet, fitness or training routines. Instead, the coach and athlete will work together to set realistic goals. Only then will the coach assesses the athlete’s abilities, fitness and potential and design a plan that offers the best chance of achieving those goals.

Similarly, investors can benefit from setting clear, realistic goals, such as the level of income they wish to live on in retirement. While longer-term goals are essential, short-term goals are as just as important as most people have financial needs that will not wait until retirement. These can include buying a new car or paying off debt and can all be built into a long-term financial plan. In this way, investors can enjoy ‘little’ victories along their journey to lasting financial well-being.

providing expert technical advice

Athletes become champions by accessing the latest technical training through updated technology and information and most importantly, a trusted coach.

Investors should also obtain as much technical detail as possible when it comes to understanding their investments.  Each individual’s circumstances are different and require a customised approach to ensure that their goals are achieved. This means that everyone requires a tailor-made strategy that suits their particular needs, whether it’s planning for retirement, organising inheritance, efficient tax planning or any other needs.  Expert financial coaches will focus on those needs and use their technical expertise to develop a sensible plan and keep it updated. This includes providing guidance on sound investment principles such as diversification.

overcoming the barriers to success

Setting clear goals and developing a strategy to achieve them are essential for athletes and investors. However, the journey towards these goals holds great challenges and rewards. This is where coaches add their greatest value!

Champion coaches help athletes put setbacks, such as injuries, behind them and tackle the psychological obstacles in the way of success. Those athletes who ignore short-term pain and set backs and remain focused on their goals are the ones most likely to attain long-term success.

Investors are distracted by similar hurdles. For example, successful investors have to learn to live with the pain of occasional market declines. This is done by understanding the difference between a short-term reduction in portfolio value and a permanent capital loss. Excessive fear results in some investors selling their assets for less than they are worth in difficult market conditions. Others may be tempted to leave their money in
low-returning assets for long periods of time.  Excessive optimism can be just as damaging. For example, investors who eagerly chase ‘hot stocks’ or ‘hot funds’ often do just as poorly as they don’t rationally assess the outlook. In these instances, an expert financial coach helps investors deal with their emotions and other behavioural characteristics that get in the way of success. Investors who can overcome the temptation to self-destruct during difficult market conditions and stay focused on simple investment principles during the good times will give themselves the best possible chance of achieving their goals.

When all is said and done, champion athletes and investors enjoy greater success by working with champion coaches.

In order to provide appropriate advice in terms of the FAIS Act, we need to have all the relevant information from a client.

Mr Page approached us for advice regarding his retirement. He was 45 years old and had belonged to his company’s pension fund for the past 20 years. He was contributing 10% of his salary of R45,000 per month to his pension fund. The resignation value of his pension fund was R1,867,000. He also had a retirement annuity to which he had been contributing R367.00 per month for the past 15 years. The underlying value was R168 400.

Mr Page wanted to know if he had made adequate provision for his retirement if he planned to retire at age 65 and wanted to receive a pension of 75% of his final salary. We went back to him and requested more information. We wanted to know what the underlying asset allocation (i.e. number of shares, gilts, bonds and property) of his pension and retirement annuity was. After some searching, he came up with the following information:

Pension Fund

• 15% Shares
• 6% Property
• 22% Gilts
• 57% Money Market

Retirement Annuity

• 32% Shares
• 15% Property
• 53% Money Market

We then went to work on establishing how much capital he would require at age 65 to provide a pension of 75% of his final salary, keeping in mind that the pension would also have to increase annually in line with inflation (6%). His final salary would be R144,321 per month; 75% of that (R144,321) would be R108,240.82 or R1,298,889.87 per annum.

The total capital required at age 65 to achieve his goals would be R21,600,798, assuming inflation of 6% during retirement, 11% capital growth and satisfying the requirement that the capital would have to last until his 95th birthday. An analysis of his current position revealed that his pension fund (with current asset allocation) would yield R12,284,374. There would be a shortfall of R9,316,423. This is largely as a result of the underlying asset allocation being too conservative.

As he had more than 10 years left to retirement, he needed to have far more equities in both portfolios. The current pension fund legislation allowed the equity exposure to be as high as 75% of the total portfolio.

We suggested that he contact his pension fund administrator and request that the asset allocation be altered to the following:

• 75% Shares
• 6% Property
• 15% Money Market
• 4 % Gilts

We altered the retirement annuity asset allocation to:

• 75% Shares
• 6% Property
• 15% Money Market
• 4 % Gilts

The new structured portfolios could yield a capital value of R26,468,086.

This would be R4,867,288 more than would be required. If this could be achieved, Mr Page could end up with a pension of R1,591,567 per annum instead of the R1,298,889.87 he required. That would equate to R132,631 per month or 92% of his final salary. So without having to invest more money from his after tax income, he could more than adequately achieve his retirement goals.

Setting investment goals and structuring the total portfolio so that it is aligned with these goals are probably the most important considerations when financial planning for retirement takes place.

As financial planners, one aspect of our commitment to our clients, is to continually be on the lookout for possible scams and investment fraud. Ian De Lange from Seed Investments wrote the following article which we believe is crucial to trying to avoid investment scams.

This week South Africa was rocked with an investment scandal, that in terms of the purported sheer size of up to R15 billion, will dwarf any previous scams. While we know that despite tight regulations, there will always be scams looking for culprits, it is very important that investors assess counterparty risk before an investment is made.

In the alleged scam of Tannenbaum billions of rands were invested into a private operating company promising investors fantastic returns. It amazes how supposed smart investors apparently put in millions without a hint of due diligence.

I found this on the CFA (Chartered Financial Analyst) website, adapted slightly for local situation. There are no guarantees, but with investments it is vital that counterparty risk is reduced to as close to zero as possible.

10 tips on avoiding investment fraud – posted after the Bernie Madoff scheme came to light.

1. Understand clearly the investment strategy – “Some investment opportunities appear alluring simply because they are described in impressive, complicated terms. Investment strategies and financial products should be clear and understandable. The nature of the risks involved can vary widely and should be well understood. Even the venerable Peter Lynch advised people to invest only in what they understood – advice he abided by in his successful career. If you don’t understand it, stay away.

2. Match investment strategy to reported performance – One of the red flags in the Madoff affair is that reported performance was too consistently good. Other investment scams, popular on the internet, purport to use ultra-safe “prime bank” financial instruments from the world’s largest banks. E-mails that promise double-digit returns are incongruent with the safe investment strategies they purport to offer. Also, find out if the firm has its reported performance numbers independently audited, who audits them, and if possible whether these figures comply with Global Investment Performance Standards, a set of ethical principles for calculating and reporting investment results.

3. Watch for e-mail solicitations and Internet fraud – The internet is a low-cost way for scammers to reach millions of people. Unsolicited e-mail messages offering you investment opportunities that sound too good to be true probably are. Online bulletin boards and electronic investment newsletters are also fertile ground to disseminate false information on thinly traded stocks for a pump-and-dump scheme. Treat information from unknown sources on the internet with great suspicion.

4. Be wary of “sure things,” quick returns, and special access – Legitimate investment professionals do not promise sure bets. Legitimate get-rich-quick schemes simply do not exist. Scammers often make the implausible combination of safety and high returns seem plausible by granting you “special access” based on your relationship with a mutual acquaintance or affiliation with a specific religion or ethnic group. Also, understand clearly the terms by which you can redeem shares or exit the investment. When can it be done and what are the fees? Ponzi schemes become unsustainable when investors pull out their money.

5. Understand what, if any, regulatory oversight exists – Fraud may be less prevalent in regulated settings, like mutual funds. Hedge funds are less regulated than mutual funds and the risks must be carefully analysed.

6. Assess the operational risk and infrastructure – Any investment management operation should have a physical infrastructure for trading and administration. Ask to see them and inquire about the firm’s processes and controls. It is important that a firm have separate, independent operations for asset management, trading, and custody to provide checks and balances against fraud.

7. Ask about independent audits and who performs them. An auditor should be independent, reputable, and congruent with the size and scope of the investment operation.

8. Assess the personnel – Ultimately, the reliability of any operation is predicated on the integrity and competence of its people. So find out who makes investment decisions and who implements the investment strategy. They should be separate people with relevant experience, education, and training. Credible investment professionals speak knowledgably and comfortably about their professional standards.

9. Perform a background check. If an advisor firm or investment manager is not listed with the FSB (www.fsb.co.za), find out why. If they are, make sure their record is clear.

10. Limit your exposure – One of the surest ways to avoid the catastrophe associated with investment fraud is to limit the amount you invest. Diversification is one of the most fundamental and enduring investment principles. Investors often expose themselves to unnecessary risks by concentrating their funds in one or two securities. By limiting your exposure to five to 10 percent of your assets, the principle of diversification can protect you if an investment turns out to be fraudulent.

Although these points cannot guarantee that you will avoid investment fraud, they will increase the likelihood that you will make smart choices.

Eighteen months ago, investors were euphorically excited about investing in shares. Risk or the danger that shares could ease didn’t play any role in decision-making. The situation at the time was almost reminiscent of vultures at a carcass.

The rest is, as they say, history. Shares are dead, or at any rate, they are like a disgraced family member - the family prefers not to talk about the situation.

The investment environment has indeed changed fundamentally.  Large companies with previously proven yield histories of more than a hundred years suddenly no longer exist. The market capitalization of others that survived has shrunk alarmingly. 

Investors are thus afraid with good reason. Few people have lived through such an economic crisis in their lifetime. Lifebuoys thrown out by governments to stabilise the economies have had little influence so far.  

Our own economy is only now really starting to feel the cold winds of change while experts warn that the worst is yet to come.

Shares are thus dead with good reason … or are they really? Although no experienced vulture will leave a fresh carcass in peace, the danger exists that investors may be allowing the biggest investment opportunity of their lives to slip through their fingers.

Although nobody can correctly predict the turning point of the bear market, several fund managers agree that there are many companies out there who will successfully survive the storms. The market has the tendency to turn while economic news is still very dark.

Could it be that investors will be caught on the wrong foot again?

If you are young or perhaps began saving recently, you can lay a solid foundation for the future by investing in a focussed shares investment strategy. In future, do not become panicky when such negative economic times re-appear. Remember that markets always move in cycles and by investing more when the markets are easing, you can really improve your total yield over time.

If you are already retired and withdraw an income from your portfolio, you must diversify to effectively counteract the negative cycles. Make sure that you have a tested investment strategy and stick to it in the long term.

If, in the longer term, the top business entrepreneurs can’t do better with their capital than a safe bank investment, then shares are indeed dead. 

Shares are dead - long live shares!

In these unprecedented volatile and uncertain financial times we often hear people say that they wished that they had rather invested in a risk-free investment, often alluding to money market funds as being risk free. The sad news is that “….there is no risk-free[1] investment.”

If we forget about the equity market for a minute and focus our attention on money market funds, I will look at the risks money market funds are exposed to:

1. Negative real interest rates
2. Credit risk
3. Liquidity risk

Negative real interest rates

This equates to the decline of purchasing power. If the rate of inflation exceeds after–tax interest rates, then the spending power of your capital in a money market fund will decline over time. This will happen even if you choose to reinvest your after-tax income. You might well say that you prefer to go backwards slowly and predictably rather than very abruptly as happened to equity markets in 2008. However, most investors probably do not want their capital to go backwards indefinitely.

When in trouble to meet their obligations, Governments around the globe might resort to printing money indiscriminately or engineer negative real interest rates. We would then end up being like Zimbabwe. If you had invested your money in an Zimbabwean money market you still would have had all your capital intact but unfortunately it would be worthless in terms of purchasing power.

Credit risk

Money markets invest in debt instruments or ‘IOUs’ which oblige the issuer of the IOU to repay a fixed money amount on a specified date within the next year. If the issuer were to go ‘bankrupt’ and default (in other words not being able to pay the full amount when it is due) the fund and the investors would bear a loss.

One way money market funds try to address credit risk is to invest the fund in a diversified portfolio of debt instruments issued by a range of issuers. This is done so that any potential losses arising from the default of any one issuer will be constrained to a limited portion of the fund’s portfolio.

The benefits of diversification will be tempered if the default of one issuer sets off further defaults by other issuers in a domino-effect crisis, as we saw happened globally in 2008. In the event of a systemic crisis like this, governments around the world have typically stepped in to shore up and stabilise the financial system.

Liquidity risk

Extreme circumstances can heighten liquidity risks. In most circumstances investors in money market funds can give one day’s notice of their intent to withdraw all their funds. All capital invested in a money market fund is not invested on a call deposit as the managers think it is unlikely that all the fund investors would suddenly want to withdraw all their funds on the same day.

By investing in longer dated paper fund managers can improve the yield earned by the fund and the investors.

Very importantly; in extreme circumstances (such as were experienced in the US money markets in 2008), withdrawals can be unexpectedly large, and this may force money market fund managers to sell its longer dated paper in order to fund the withdrawals. If this paper is sold at a loss (as there may be other money market funds all trying to sell the same paper at the same time), then that loss will be borne by the money market fund and the investors.

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