NFB FINANCIAL UPDATE

Issue66 February2013

FROM THE CEO’s DESK

Welcome all to 2013, and

congratulations on surviving the End

of the World, as predicted by the

Mayans for December 2012.

However, before we go back into the New Year

celebrating this lucky break, we need to reflect on

the environment both in sunny S.A. and abroad,

from a markets, politic and broad societal

perspective.

2012 was in some cases gentle, in most cases

generous and in a few cases remarkable in

rewarding investors in a broadly bankrupt world,

with broadly inflation beating returns. For those

brave enough to remain or venture into equities,

the local market returned 25%, the balanced funds

which we favour, between 15% and 20%, bonds

delivered a remarkable 16%, given the state of

government's indebtedness, but undoubtedly the

star of the show was listed property, again eclipsing

all comers with a return for the year in the mid

thirties. Lagging well behind the peer group, and

narrowly losing out to inflation was cash, returning a

meager 5% before tax!

The rand, having been somewhat of a global

bully over the last number of years, retreated over

the year, bouncing around and settling weaker

against all comers.

And so on to the year and, indeed, years

ahead. NFB seldom lapse into the predictive

space, although requests to provide investors with

reasonable forecasts are usual and most often

takes pride of position in reviews and when

applying new funds. The art to successful investing

relies rather heavily on a few trump cards. These

include, in no specific order:

! A clear understanding of the investor's goals and

a reduction of these to writing in the form of an

investment objective made measurable through

expression in the form of a benchmark. For

example: an investor's goal might be to have

funds available in retirement, their objective

would be to provide for retirement income

through retirement savings and their benchmark

might be to ensure that their retirement savings

generates a return over meaningful periods (we

would suggest periods between three and seven

years) in excess of inflation;

! A clear understanding of the correlation

between risk and return;

! Defined time lines, i.e. how long the funds can be

deployed without needing to be switched,

loaned against or redeemed;

! Understanding volatility in returns, both between

styles of managers and asset classes;

! Real and after tax returns. Far too often we see

examples of folk being satisfied with a return on a

cash or money fund, which at first blush appears

superior to another fund. However, on reflection,

the other fund delivers dividends, which may

enjoy a far superior after tax return;

! Optimization of tax efficiency. Using products,

wrappers and strategies which look to minimize

the tax and cost drag on returns.

I, and all of the advisory teams at NFB,

continually wrestle with these intertwined issues and

others, in seeking to deliver to clients, each with

their own unique set of circumstances, gratifying

returns. In these times of low yields, crazy volatility in

markets and asset prices, and generally

acceptable returns, the importance of repeatedly

reflecting on these criteria cannot be overstated.

Overseas bonds, particularly investment grade

non-government bonds have enjoyed a great rally.

Whilst other yields still remain much lower, it is

prudent to watch this asset class for signs of

becoming oversold, resulting in the switching of the

funds to lower yielding cash, property or high

dividend paying equities. Parties never go on

forever and typically, the longer they do, and for

the stayers, the risk is big of a serious hangover!

In the local market, as seen in the returns noted

above, our property sector appears more than a

little heated. It must be said that this same

comment could easily have been made a year

ago, but now we are at record highs with little

room for the key players to misfire without triggering

a material sell-off. When confronted with these

tough choices of staying the chase or baling out

into less choppy waters, I tend to believe that if the

unexpected gain already accrued is rather

important in upping your access to income, bank

some. If this is not true, i.e. it is excess to

requirements, then one can choose to stay, brace

everything down and hopefully enjoy the ride.

Turning to matters domestic, we are witnessing

a rather disturbing level of social unrest, particularly

in the Western Cape, perhaps not by fluke, the

home of the DA ruling Provincial Party. The violent

nature of the so-called strike worries me, and when

seeing the levels of intimidation, destruction of

uninvolved property, I run scared. This is not good

for SA Inc. and we need to respect the vast

alternative choices available to investors, both the

very important long term industrialists and property

investors, as well as the more flighty portfolio flows

which have funded our national “overdraft” or

government borrowings. If this was to materially

IN THIS ISSUE

From the CEO’s desk

Inflation and retirement:

the silent killer

f i n a n c i a l s e r v i c e s g r o u pcontinued on the back page...

A new chapter in offshore investingThe Old Mutual

International Investment Portfolio

INFLATION AND RETIREMENT

hile many of us sit and contemplate the reality that

Wwe may have to retire at some point in the future,

statistics show that in reality not many South Africans

can actually afford to retire when that day does

arrive. This is often because of:

not starting to save early enough for retirement

not saving enough during our working careers

using previously saved retirement assets for living expenses

before retirement

poor investment returns

poor financial planning strategies

with increased life expectancies, funds available at retirement

need to provide income for longer periods.

The focus of this article is to illustrate the effects of inflation on

both retirement assets as well as retirement income requirements.

The points mentioned above are a few reasons that can

significantly impact the amount of income that can be drawn

during your retirement years. In many instances, the impact of

inflation on investment returns and the future cash flow that your

retirement portfolio can generate is not well understood, or is

completely ignored. This lack of understanding of the impact of

inflation during retirement can be disastrous as it can result in an

unrealistic expectation as to what type of income a portfolio can

generate and sustain. This in turn lulls investors into a false sense of

security prior to retirement in terms of the amount of money investors

save, and can result in unsustainably high drawings during

retirement.

When reviewing and recommending retirement and investment

products and anticipated investment returns for these vehicles, we

often come across the question of “how much income can an

investment generate, without eroding the capital of the

investment?”. The answer to that question is simple. If one draws at

a rate equal to the return on the investment, the capital value of

the investment will remain intact. There is, however, a massive

problem with this line of thinking in that it doesn't take inflation into

account – and this is one of the biggest problems that a retired

investor faces.

Let's start off by explaining what inflation isWhen we talk about the rate of inflation, this refers to the rate of

inflation based on the consumer price index, or CPI for short. The

South African CPI shows an indexed level of the prices of a standard

“basket” of goods and services which South African households

purchase for consumption. In order to measure inflation, an

assessment is made of how much the CPI has risen in percentage

terms over a given period compared to the CPI in a preceding

period. If prices have fallen this is called deflation (negative

inflation). So if the rate of increase in the CPI is 5%, this means that

the price of the basket of goods and services (as determined by

Stats SA) has increased by 5%. It is important to note that this is

simply a barometer to indicate general price increases in the

economy. One's personal household's inflation will be different from

official CPI and is determined by what that specific household

consumes. In many instances, CPI may in fact understate the rate of

price increases that households experience. For the purpose of this

discussion, we will stick to the official CPI measure.

So why is inflation a problem?We all know that the cost of living increases every year as a result of

increases in things such as food prices, electricity prices, fuel prices,

and the like. Thus it is logical that in retirement, our income needs to

increase in line with inflation to ensure that we can afford to meet

our expenses as they increase every year. And this is where the

problem lies.

If we were to subscribe to the logic of drawing at a level that

equals the rate of return, we would have the same amount of

capital invested at the end of the year. But in reality, the value of

that investment, when adjusted for inflation, has in fact decreased.

Similarly, while the amount of income that is drawn may stay the

same each year, after the effects of inflation are taken into

account, the “real” (or inflation adjusted) value of the income

diminishes year on year. This is illustrated by the example below:

Client age 55

Initial investment R4,000,000

Rate of return 10%

Drawing Rate 10%

Inflation 5%

As can be seen by the two graphs above, while the value of both

the capital and income stay constant (in what we call nominal

terms), the real (or inflation adjusted) value falls year after year. In

this example, the real value of the investment, as well as the real

value of the income that it generates halves in 12 years.

Thus it is clear to see that while at face value, drawing at the

rate of return will protect the capital and income, this is not the case

when inflation is taken into account. Mathematically this is

explained as follows:

Nominal Return 10%

Less: Drawing 10%

= Net Nominal Return 0%

Less: Inflation 5%

= Net Real Return -5%

It is clear then that in order to protect both income and capital

against inflation, it is necessary to draw at a rate that is lower than

the return. In fact, if one wanted to fully protect an investment and

the income it generates against inflation, it is logical to suggest that

the rate of return less the rate of drawing, should be equal to

inflation. Using the same assumptions as above:

Nominal Return 10%

Less: Drawing 5%

= Net Nominal Return 5%

Less: Inflation 5%

= Net Real Return 0%

In this instance, while both the capital and income levels grow from

year to year, when inflation is taken out, the values in real terms stay

constant protecting the client against inflation. Thus the initial

R4,000,000 investment is maintained (in real terms), while the

sustainable income level of R18,000 per month is protected. This

scenario is illustrated below:

What does this tell us:The most important lesson that we learn from all of this is that the

rate of return on our investments is not the same thing as the

sustainable drawing level on the investment. In fact, to determine

the sustainable drawing level of an investment, one needs to take

the expected return and subtract the expected rate of inflation. This

will allow the net growth on the investment to be in line with

inflation, thus protecting the real capital and income levels of the

investment.

If one assumes an expected rate of return is 10%, and inflation

of 5%, a sustainable drawing level is at maximum 5% per annum.

In practical terms, this means that R1,000,000 of capital can

sustainably generate around R50,000 of income per annum. While

this is far lower than many investors would like to believe, it is a

reality that we need to face.

In order to increase this income, one would have to achieve

higher rates of return. To achieve this, higher levels of risk need to be

taken within a portfolio. Investors, however, need to carefully

consider and understand the implications of risk – especially once

retired, as the consequences of capital loss are exacerbated by the

fact that during retirement income is being drawn from the portfolio.

That is to say that if one draws 10%, and the investment loses 15%

(by virtue of being in an aggressive portfolio), the capital value will

be down by 25% in nominal terms, and 30% in real (inflation

adjusted) terms (assuming inflation of 5%). To then get the same

amount of income in rands and cents, the drawing rate has to be

pushed up to around 15% as a result of the lower capital value of

the investment. This scenario can result in massive capital erosion in

a very short space of time.

How much is enoughSo back to the issue of “how much do I need to retire?”.

Unfortunately, there is no universal answer to this question, as it is

specific to one's personal circumstances and needs, and is reliant

on uncertain factors such as expected rates of return, and future

inflation rates.

While the discussion above is sobering, it does, however,

empower us with knowledge that we can apply, in that it informs us

of what a sustainable drawing rate is. So when answering the “how

much is enough” question, we need to consider some of the

following factors:

What is the value of your current investable assets?

How much does one contribute to these assets on a monthly

basis?

How much income do you need in retirement to meet your

monthly requirements?

What are the current and expected rates of return on the

portfolio?

What is the expected level of inflation?

Prior to retirement these questions can help investors with

decisions around savings rates, the risk profile of their investments, as

well as around managing their expense levels more effectively so

that at retirement, their expenses and sustainable income are

commensurate.

When closer to retirement, understanding the impact of inflation

on capital and drawings can help investors carefully consider the

level of drawing they select to ensure that their savings are

managed in such a way as to provide income sustainably into the

future.

Retirement planning and the impact of inflation are vitally

important aspects of financial planning. We strongly suggest that

you discuss these issues with your NFB advisor.

Ima

ge

cre

dit: 1

23

RF

Sto

ck P

ho

to

INFLATION AND RETIREMENT

The effects of inflation on both retirement assets as well as

retirement income requirements. By Andrew Duvenage &

Grant Magid, NFB Gauteng, Private Wealth Managers

THE SILENT KILLER

INFLATION AND RETIREMENT

hile many of us sit and contemplate the reality that

Wwe may have to retire at some point in the future,

statistics show that in reality not many South Africans

can actually afford to retire when that day does

arrive. This is often because of:

not starting to save early enough for retirement

not saving enough during our working careers

using previously saved retirement assets for living expenses

before retirement

poor investment returns

poor financial planning strategies

with increased life expectancies, funds available at retirement

need to provide income for longer periods.

The focus of this article is to illustrate the effects of inflation on

both retirement assets as well as retirement income requirements.

The points mentioned above are a few reasons that can

significantly impact the amount of income that can be drawn

during your retirement years. In many instances, the impact of

inflation on investment returns and the future cash flow that your

retirement portfolio can generate is not well understood, or is

completely ignored. This lack of understanding of the impact of

inflation during retirement can be disastrous as it can result in an

unrealistic expectation as to what type of income a portfolio can

generate and sustain. This in turn lulls investors into a false sense of

security prior to retirement in terms of the amount of money investors

save, and can result in unsustainably high drawings during

retirement.

When reviewing and recommending retirement and investment

products and anticipated investment returns for these vehicles, we

often come across the question of “how much income can an

investment generate, without eroding the capital of the

investment?”. The answer to that question is simple. If one draws at

a rate equal to the return on the investment, the capital value of

the investment will remain intact. There is, however, a massive

problem with this line of thinking in that it doesn't take inflation into

account – and this is one of the biggest problems that a retired

investor faces.

Let's start off by explaining what inflation isWhen we talk about the rate of inflation, this refers to the rate of

inflation based on the consumer price index, or CPI for short. The

South African CPI shows an indexed level of the prices of a standard

“basket” of goods and services which South African households

purchase for consumption. In order to measure inflation, an

assessment is made of how much the CPI has risen in percentage

terms over a given period compared to the CPI in a preceding

period. If prices have fallen this is called deflation (negative

inflation). So if the rate of increase in the CPI is 5%, this means that

the price of the basket of goods and services (as determined by

Stats SA) has increased by 5%. It is important to note that this is

simply a barometer to indicate general price increases in the

economy. One's personal household's inflation will be different from

official CPI and is determined by what that specific household

consumes. In many instances, CPI may in fact understate the rate of

price increases that households experience. For the purpose of this

discussion, we will stick to the official CPI measure.

So why is inflation a problem?We all know that the cost of living increases every year as a result of

increases in things such as food prices, electricity prices, fuel prices,

and the like. Thus it is logical that in retirement, our income needs to

increase in line with inflation to ensure that we can afford to meet

our expenses as they increase every year. And this is where the

problem lies.

If we were to subscribe to the logic of drawing at a level that

equals the rate of return, we would have the same amount of

capital invested at the end of the year. But in reality, the value of

that investment, when adjusted for inflation, has in fact decreased.

Similarly, while the amount of income that is drawn may stay the

same each year, after the effects of inflation are taken into

account, the “real” (or inflation adjusted) value of the income

diminishes year on year. This is illustrated by the example below:

Client age 55

Initial investment R4,000,000

Rate of return 10%

Drawing Rate 10%

Inflation 5%

As can be seen by the two graphs above, while the value of both

the capital and income stay constant (in what we call nominal

terms), the real (or inflation adjusted) value falls year after year. In

this example, the real value of the investment, as well as the real

value of the income that it generates halves in 12 years.

Thus it is clear to see that while at face value, drawing at the

rate of return will protect the capital and income, this is not the case

when inflation is taken into account. Mathematically this is

explained as follows:

Nominal Return 10%

Less: Drawing 10%

= Net Nominal Return 0%

Less: Inflation 5%

= Net Real Return -5%

It is clear then that in order to protect both income and capital

against inflation, it is necessary to draw at a rate that is lower than

the return. In fact, if one wanted to fully protect an investment and

the income it generates against inflation, it is logical to suggest that

the rate of return less the rate of drawing, should be equal to

inflation. Using the same assumptions as above:

Nominal Return 10%

Less: Drawing 5%

= Net Nominal Return 5%

Less: Inflation 5%

= Net Real Return 0%

In this instance, while both the capital and income levels grow from

year to year, when inflation is taken out, the values in real terms stay

constant protecting the client against inflation. Thus the initial

R4,000,000 investment is maintained (in real terms), while the

sustainable income level of R18,000 per month is protected. This

scenario is illustrated below:

What does this tell us:The most important lesson that we learn from all of this is that the

rate of return on our investments is not the same thing as the

sustainable drawing level on the investment. In fact, to determine

the sustainable drawing level of an investment, one needs to take

the expected return and subtract the expected rate of inflation. This

will allow the net growth on the investment to be in line with

inflation, thus protecting the real capital and income levels of the

investment.

If one assumes an expected rate of return is 10%, and inflation

of 5%, a sustainable drawing level is at maximum 5% per annum.

In practical terms, this means that R1,000,000 of capital can

sustainably generate around R50,000 of income per annum. While

this is far lower than many investors would like to believe, it is a

reality that we need to face.

In order to increase this income, one would have to achieve

higher rates of return. To achieve this, higher levels of risk need to be

taken within a portfolio. Investors, however, need to carefully

consider and understand the implications of risk – especially once

retired, as the consequences of capital loss are exacerbated by the

fact that during retirement income is being drawn from the portfolio.

That is to say that if one draws 10%, and the investment loses 15%

(by virtue of being in an aggressive portfolio), the capital value will

be down by 25% in nominal terms, and 30% in real (inflation

adjusted) terms (assuming inflation of 5%). To then get the same

amount of income in rands and cents, the drawing rate has to be

pushed up to around 15% as a result of the lower capital value of

the investment. This scenario can result in massive capital erosion in

a very short space of time.

How much is enoughSo back to the issue of “how much do I need to retire?”.

Unfortunately, there is no universal answer to this question, as it is

specific to one's personal circumstances and needs, and is reliant

on uncertain factors such as expected rates of return, and future

inflation rates.

While the discussion above is sobering, it does, however,

empower us with knowledge that we can apply, in that it informs us

of what a sustainable drawing rate is. So when answering the “how

much is enough” question, we need to consider some of the

following factors:

What is the value of your current investable assets?

How much does one contribute to these assets on a monthly

basis?

How much income do you need in retirement to meet your

monthly requirements?

What are the current and expected rates of return on the

portfolio?

What is the expected level of inflation?

Prior to retirement these questions can help investors with

decisions around savings rates, the risk profile of their investments, as

well as around managing their expense levels more effectively so

that at retirement, their expenses and sustainable income are

commensurate.

When closer to retirement, understanding the impact of inflation

on capital and drawings can help investors carefully consider the

level of drawing they select to ensure that their savings are

managed in such a way as to provide income sustainably into the

future.

Retirement planning and the impact of inflation are vitally

important aspects of financial planning. We strongly suggest that

you discuss these issues with your NFB advisor.

Ima

ge

cre

dit: 1

23

RF

Sto

ck P

ho

to

INFLATION AND RETIREMENT

The effects of inflation on both retirement assets as well as

retirement income requirements. By Andrew Duvenage &

Grant Magid, NFB Gauteng, Private Wealth Managers

THE SILENT KILLER

A NEW CHAPTER IN OFFSHORE INVESTING

A licensed Financial Services Provider

Johannesburg Office:

NFB House 108 Albertyn Avenue Wierda Valley 2192,

P O Box 32462 Braamfontein 2017, Tel: (011) 895-8000 Fax: (011) 784-8831

E-mail: nfb@nfb.co.zaWeb: www.nfbfinancialservicesgroup.co.za

East London Office:

NFB House 42 Beach Road Nahoon East London 5241, P O Box 8132 Nahoon 5210,

Tel: (043) 735-2000 Fax: (043) 735-2001E-mail: info@nfbel.co.zaWeb: www.nfbec.co.za

Port Elizabeth Office:

110 Park Drive Central Port Elizabeth 6001, P O Box 12018 Centrahil 6001,

Tel: (041) 582-3990 Fax: (041) 586-0053E-mail: info@nfbpe.co.za Web: www.nfbec.co.za

As funds with foreign exposure start to outperform their domestic

counterparts, and economists warn that domestic markets are

overpriced, investors seeking maximum returns are starting to test

foreign waters again. Old Mutual International has responded by

offering a new product, called the Investment Portfolio, which offers

incomparable benefits.

ONE WRAPPER FOR ALL YOUR ASSETSThe product itself is a life wrapper designed to hold offshore assets

such as share portfolios, unit trusts, exchange-traded funds, currency

accounts and structured notes. There are a number of benefits for

using the wrapper, the most impressive being tax efficiency.

TAX-FREE RETURNSMost products that were previously used for offshore investment

involved the appointment of the contract holder/s as lives assured

under the policy, and company tax rates (currently 30%) were

applied to all returns. The Investment Portfolio is structured so that it

does not have lives assured and there is no tax in South Africa in

respect of returns earned. Buying and selling assets within the

portfolio will not attract a Capital Gains Tax liability, and the final

proceeds received on redemption of the contract will be tax-free,

provided they are received by the original beneficial owner of the

policy.

ESTATE PLANNINGBecause there are no lives assured, the investment will not

automatically come to an end upon death of the contract holder.

The investment can continue for up to 99 years unless it is fully

surrendered by the contract holder, or by his/her executors

following death. You can also nominate beneficiaries to whom the

contract will be transferred upon death, rather than to your estate,

and this will avoid probate, reduce delays and costs in wrapping up

your estate, and gives you the assurance of knowing what will

happen with the investment. In the past, many investors have seen

fit to appoint offshore trusts in order to carry out their wishes in terms

of their offshore portfolios after their passing. This can be a costly

and time consuming task, and the Investment Portfolio takes care of

this.

RESTRICTIONSThe only drawback is that only a restricted amount may be

withdrawn within the first five years of investment. This is a small price

to pay considering that offshore investing should only be

undertaken with a long term view of five years or more.

In essence, the Investment Portfolio is a simpler and more efficient

product for offshore investment than has been offered in the past. It

allows you to combine a number of different assets within one

portfolio and lifts the burden of administration and reporting from

your hands. In addition, the fact that your returns are not reduced

by income tax ensures that you will benefit from the maximum

returns possible.

After a decade of disappointing returns,

offshore investing is once again in the spotlight.

By Mikayla Collins, NFB Western Cape, Private

Wealth Manager

A NEW CHAPTER IN OFFSHORE INVESTING

Ima

ge

cre

dit: 1

23

RF

Sto

ck P

ho

to

slow down, never mind reverse, we could witness a dramatic

weakening of our currency. This in itself is a double-edged sword,

aiding the efforts of our industrial, mining, commodity and tourism

sectors, but bedeviling the borrowing costs of the government as it

strives to inject capital into the development of infrastructure and

our broader budget spend. Of critical importance is the delivery of

services and improved standards of living to the broader

population. Suggestions that these people should look after

themselves is a non-starter as they haven't got a dog's chance of

even getting into the game. They need a hand up, and in South

Africa, as is the case around the world, this is where it starts from.

One agrees that a successful state is not created by taking from

the rich to sort out the poor, but if we are to avoid the risks faced in

the north of our continent over the last year or two, we need to take

ownership of these issues. They will not go away by us denying they

exist. I have listened to leaders in politics and business debating

these issues and it is somewhat reassuring that they are enjoying lots

of attention, although as is often the case, this positive news doesn't

sell newspapers and is therefore not aired publically. I must say that

Mr Ramaphosa being elected into the number two seat in the ANC

makes me happier. He enjoys popular support, has a sound

following beyond our borders and certainly knows his way around

business South Africa and beyond. Every cloud………..

To all of our clients and supporting peers in the life of NFB we

wish you well for the year ahead. As one wag was reported to have

twittered, one day before the Mayan Doomsday, “my wife got us

tickets to The Nutcracker for tomorrow night, so at this point I'm

rooting for the Mayans”.

Thank you for your continued support.

®Mike Estment, BA CFP

CEO, NFB Financial Services Group

FROM THE CEO’s DESK continued from page one...

THE OLD MUTUAL INTERNATIONAL INVESTMENT PORTFOLIO