THE STERLING TIMES 13 JULY 2015
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THE STERLING TIMES 13JULY 2015
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Inside this issue
02 Introduction Graydon Morris
03 Challenging the Risks of Isolation: The Trip to Japan and Singapore Joubert Strydom, Director
06 So you think you are prepared? Think again
08 Davis Tax Committee Estate Duty Report
12 Diversification Lesley Hohne, Director
14 Adviser Market Report: 30 June 2015
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Introduction
Graydon MorrisFounding Director
As always, it is amazing to think we are more than half way through 2015.
It has been a busy year for us all and we have been very busy dealing with many investor concerns around the future of our country and the related long term invest-ment thesis.
We have attempted to be pragmatic and sensible in our approach to these matters; investing is no place for irra-tional emotions to be allowed to dominate and options need to be considered carefully and in the context of each investor’s circumstances.
The year, again, has been marked by many opportuni-ties and challenges, politically, in South Africa. With the ongoing Eskom sagas, Nkandla, the embarrassing Parlia-mentary Fracas, and weakened Rand, many of our clients are skittish with regards to the outlook for our beloved country. We sense a lot of anxiety, politically, within our investor base at present.
“Filter the Noise” has long been one of our Wealth Man-agers edicts and pleas to investors. It is no different at present. There many divergent investment opinions, all of which may play out in the very short term, but in the long term, quality at the right price and diversification is what assists in meeting our varying, but necessary goals.
We re-emphasise our roles as a level-headed sounding board and independent partner in terms of investment decision-making.
We have shared the below with you before, but highlight it again, as it has evergreen relevance.
Our Model Portfolios, available on the Allan Gray and Investec Platforms, have now been in existence for a year.
We are delighted with this development that streamlines our portfolio management, in conjunction with Fundhouse and our Investment Team at Counterpoint Boutique Asset Management. The Fundhouse Market Report is provided at the end of this Newsletter.
One of our Directors, Joubert Strydom, recently undertook a fact finding mission to Japan and Singapore. He shares his insights and experience with you in this edition.
A client of ours recently kindly shared with us a checklist that they compiled following the passing of a spouse. Whilst many of the required details and information is readily available at our offices, there are many that are outside of our realm, and the “Checklist” may be of interest to you.
The Davis Tax Committee recently released its report on Proposed Estate Tax change. For your records, we provide a summarised version for you to consider. This remains work in progress and we shall be communicating with our clients where relevant action may be required.
We conclude this edition with an important article from one of our founding directors, Lesley Hohne, that speaks to the importance of Diversification and the various fal-lacies surrounding this approach.
Graydon Morris Founding Director
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For millenniums the act of isolation has been a method to punish, but also to protect, or in some cases used to force opposition into submission. Of late, didn’t it feel as if South Africa has been on the disastrous road of isolating ourselves from the rest of the world through xenophobia, soccer world cup accusations, low productivity on the economic front, association with unsavoury public figures and political organisations, and recently through a total disregard for international law?
In an effort to guard against my own isolation and the for-feiture of competitiveness, I was recently fortunate enough to embark on a fund manager visit to Asia together with a number of peers in our industry. With Eastern Markets representing a larger portion of the world economy every year, we felt it important and critical to be familiarised with that part of the world. On returning home from attending, amongst other things, fund manager meetings, as well as two investment seminars in Singapore and in Tokyo, I tried to express in my feedback to colleagues and business partners, my assessment on what the effect of isolation can mean for people and how differently the outcome of such threatening circumstances can be.
As you are aware, Singapore and Japan are both island countries that could very easily be isolated and kept under siege, and eventually forced into surrender. That was of
course, one of the main reasons why Japan, with the threat of China across the Sea of Japan, was one of the last countries to surrender at the end of World War II. Notwithstanding this threat, both these countries have excelled over the past 50 years plus, and have been used as an example for many studies and lectures.
Many travellers have had the opportunity to stopover in Singapore en route, and enjoy this wonderful economic success story first hand. Singapore is currently celebrating its 50th year of independence, whilst the motivational and farsighted leader, Lee Kuan Yew - some even called him a benign dictator - passed away earlier this year. Under his reign since independence in 1965, the country moved away from British rule, with a brief stint as part of Malaysia, only to become a wonderful example to the rest of the world. Kuan Yew drove and inspired Singapore to become a first class world city and country that is only half the size of Johannesburg.
It is hard to believe that Singapore is an island with no natural resources, very little water and not much else going for it due to the almost year-round unbearable tropical heat. However, this country has become one of the three busiest ports in the world, has a place in the top five stock markets, and for good measure, enjoys the influx of tourists equal to that of the total South African population per year. Not bad for a country that only has 3.5 million Singaporeans, whilst a further 1.5 million are foreign workers living in the country. Singapore continues to reclaim land at an astonishing rate. In doing so, driving the hundreds of anchored and waiting containerships, and especially oil tankers outside the harbour, literally deeper and deeper into the sea! In the 15 years since my previous visit, some of the statues like the well-known Merlion, had to be moved some 2 km to be closer to the seashore, as it would otherwise have been standing in the middle of the city centre!
This was a country that was somewhat forced into accept-ing the long-term vision their leader had for the country and today the underground and pavements do not show
Challenging the Risksof Isolation: The Trip to Japan and SingaporeJoubert StrydomDirector
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any trampled-in chewing gum blotches which is so notice-able in other major world cities. Yes, chewing gum was actually banned as part of the vision to create a clean and a breathtakingly beautiful city!
Singapore is a country that, despite accommodating a large foreign labour influx through significant job creation, does not grapple with the phenomenon of unemploy-ment. Economic growth is expected to be around 5% this year, whilst the astonishing GDP per capita of US$83 000 is more than 5 times that of South Africa. This, after being only half of South Africa’s GDP per capita 30 years ago! This type of growth and prosperity can only happen through a work ethic and a common vision by a will-ing nation. We witnessed a good example of this work ethic one Friday evening at 11 o’clock, when walking back to our hotel: we noticed building teams still in full operational swing under flood lights to complete another massive skyscraper!
Singaporeans work very hard and long hours in order to showcase a country that serves as a gateway to the East that is efficient, friendly, and clean with every delivery prompt and exceeding expectations.
Whilst Singapore, through their 50 years’ endeavours to embrace the world, have overcome the threat of isolation, Japan in my experience, has built a moat around their country that is second to none.
Nevertheless, Japan and the Japanese people left an impression on me like no other country has done before. To call it the ultimate, or pinnacle of civilisation, is no exaggeration!
We as a group had to call on Investec Asset Management to arrange meetings with fund managers like Black Rock, Morningstar, as well as Japanese Asset Managers, because to have found our own way around would have been extremely difficult and challenging. Not only is Japan an unknown country far away in the Pacific Ocean, but the barriers created by language, culture, and food makes it
very difficult for foreigners to find their way around on this island...
In an effort to give context to my experience I have regu-larly referred to the following examples:
1. For 7 days in Japan we did not see a single piece of paper, or litter lying around anywhere – not even in the major cities. In fact, it was even difficult to find a dustbin! Whatever rubbish you generate you carry with you until you eventually find a battery of recycling dustbins, or until you get home to do your rubbish sorting and incineration.
2. The train conductor on one of the most efficient trains you can ever experience travelling on, would enter the coach to check tickets (I don’t know why this was even necessary!) and would bow greater than 45 degrees to greet all travellers in that specific coach. After completing his task and before exiting the coach on the other side, he would turn around and again bow low, out of respect for the passengers, before closing the door and exiting.
3. In one of the meetings I also witnessed the respect that a junior colleague bestowed on his senior. He sat next to his senior who was doing a presentation for us, with folded hands looking down at his notes, never once interjecting or interrupting, nor offering any comment or even looking up, whilst his senior battled through the presentation with his limited English. Eventually during question time, his senior asked him if he would like to answer a specific question. To our amazement, not only was his English impeccable, but we also thought that his knowledge on the markets and specifically the question asked, was far superior to that of his senior. But out of respect, he refrained from interrupting, and did not risk embarrassing his senior colleague in front of us!
4. Tipping for services rendered does not exist as the Japanese pride, dignity and integrity does not require
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any enticing as it is always of impeccable standard and quality!
One of the major problems in this fastest aging population in the world, is that there just aren’t enough young people entering the labour market to contribute to economic growth. Therefore Japanese investors are willing to invest all their capital with a bank and only earn 0.316% p.a. in cash! Fortunately, due to the deflationary environ-ment of 2%, investors are earning in excess of 2% p.a. in real terms on cash! Notwithstanding this, the per capita wealth is increasing every year, and on the back of full employment there is minimal crime, apart from the odd white-collar misdemeanour.
Interestingly, business and government are on a drive to entice 65 to 70 year old pensioners back into the work-place. Their pensioners are being accepted into the work-force just as other countries would accept their youth as newcomers to their labour environments. The other big drive in Japan is to increase tourism. Since the recent tsunami and nuclear scares, the industry has had a tough time luring visitors to Japan. Unfortunately, the language barrier with all signs and notices only being displayed in Japanese, makes getting around Japan relatively difficult, if one is not travelling in an organised group.
Nevertheless, it is a pleasure taking any one of the immacu-late taxis with drivers all dressed in black suits and ties, wearing white gloves. As was the case with trying to spot any litter, so not a speck of dust could be detected on any of these black taxis! At the destination they always have the exact change available because remember, they don’t accept tips!
Unfortunately we could not visit the rim of an active volcano as there had been some activity in the time that we were there, which resulted in about 30 tremors during the day. During our 2 day stay in the hotel only 700 m away from the volcano rim, we were able to physically feel about 10 tremors! The disappointment of not being able to visit the rim was lessened by being served the most exceptional beef steak that I have ever eaten in my life: 80g of Wagu beef – as opposed to the 500g monster
cuts that we are used to in South Africa!
Notwithstanding the wonderful experience that left us in awe, it was concluded that our own financial services industry does not have to stand back for either the Singa-porean or Japanese industries. The main reason that the Japanese industry is still lagging behind the Australian, US, UK and South African industries is because 60% of investments in Japan are being held only in bank deposits. A maximum 14% of all investments are in collective invest-ment schemes, or unit trusts, as we know them in South Africa. Another project embarked upon by the Japanese authorities is to try and create a greater awareness through active marketing and trying to persuade investors to enter stock market investments in order to obtain more fruitful long-term investment growth.
Unlike Singapore, there are very few foreigners working in Japan due to the barriers created by language, culture, and food. This isolated population of 127 million people, living in an area smaller than 25% of South Africa, can be regarded as one of the most impressive, respectable, humble, hardworking, and organised nations in the world.
It is unlikely that I shall have the privilege of visiting Japan again in my lifetime, but as I have said to a number of peo-ple: “If I ever need to have my faith in mankind restored, I would go back to Japan and experience true civilisation”.
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The gift of Life is so rare and a precious thing, but fragile and fleeting, and can be gone in an instant. Just how ‘equipped’ are you to deal with that time, when it comes, when your Spouse (or a Parent) dies?
Hereunder is a list of things we believe most people, to a larger or lesser degree, will most likely have to be able to lay their hands on, to help facilitate the process of winding up an Estate. With the exception of a Will, which is vital, all the rest come in no particular order of importance, but, for most part, are things we have found are needed:
• (Current)WILL – who is it lodged with/where is it kept. (Hopefully you will be aware of what your partner’s wishes were in regard to items of more sentimental value (not specified in the Will), discuss which child should receive what, so that there can be no strife…e.g. dad’s bible, watch or tool if there is more than one son. In the case of daughters, who should receive mom’s rings etc).
• DrawupaNEW WILL as soon as possible if necessary.
• WhoisthenominatedExecutor/Executrix?
• Ifyoucan,haveaFuneral home in mind to assist you with the urgent medical and legal requirements in regard to the person, and other arrangements they may have available for your convenience. They should be able to supply you with both the Original Death Certificate (do NOT let this out of your hands) and the numerous certified copies, which you will be needing, to supply to any who may request it. (Bank / Pension Company / Insurance / stop and debit order companies, etc.)
• IfdocumentationofanykindisinaSafe / Bank Vault / Stor-age Locker - where are the keys / what is the combina-tion code?
• Whataretheperson’swishes–Burial (which Cemetery) or Cremation (scatter the ashes where?) Are they Donors – who to contact. Decide as a family who would want to see the body of the deceased before cremation or
burial.
• Life Policies – name the Company (good to have a contact name) and Policy No(s). These policies will be paid out immediately.
• Pension – with which Company (If the person is retired it may not necessarily still be held with the Company he was last employed with.)
• Cell – know the Pin No. , PUK no. and Contract details.
• ID book and Passport (s) should be in one place. (Your chil-dren may need these if you have a foreign passport.) Make a number (start with 10) of copies of their ID and get these Certified – do this before the ID book front page is stamped “Deceased”.
• Ifthepersonhasanyforeign Pension monies or income, make sure you know what it is, how much it is, who it comes from and how to get hold of the relevant Person/ Institutions – both to advise the death of the person concerned, and to find out what you need to do next.
• Marriage and Birth Certificates. You will need proof of the fact that you are still legally married – Pension Fund requirements.
• Insurance Policies (House / Vehicles) what are the pre-miums being paid – you will have to continue to pay to maintain the Cover. Make sure that you continue to be covered under these policies while the Estate is being finalized.
• Investments (Know if there are monthly deposits being made in to any account.) Know which Companies hold the Policy and keep a list of all the Account / Policy Nos. Know too if they are Living Life Annuities, Endowments policies, etc.
• HaveaBank / savings account of your own where you can immediately access money.
• Accounts which are paid monthly and how they are
So you think you are prepared? Think again
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usually paid must be available/known to you. This must include any stop/debit orders coming off your partner’s current/credit card account (i.e. municipal-ity / tv/ dstv / premiums / cell phone / garage card, etc).
• Internet banking: If your spouse uses internet banking, ensure that you know the PIN and passwords, and how to use the facility. It is the quickest, easiest way to move cash around.
• Understandherethat,untilsuchtimeastheExecutorhas received a Letter of Executorship from the Master of the Supreme Court, any account in your partner’s name will be frozen, and all monthly payments / premiums will still have to be paid by you. This will continue until such time as the account holders name and banking details are changed, which can only happen when you have a Letter of Executorship acknowledging who the Executor is. If you are not the Nominated Executor, you will have to get this letter from the person to enable you to make the necessary changes required.
• KnowwhoyouwouldappointasyourAttorney, if you are the Nominated Executor. Dealings with the Master are complex and fiddly and you will not man-age this on your own. Legally you won’t be allowed to either, unless you have the qualifications to do so. The Master could also require certain other informa-tion from you, such as making a Provisional List of the deceased person’s Assets and Income. This may be needed for a number of reasons i.e. if there is more than one beneficiary or if there is a possibility of the Estate being Bankrupt or being insolvent.
• MakesureyouareentitledtodrivetheMotor Vehicle, if it is licensed in the spouse’s name – remember that the car will also form part of the Estate, which will take many months to be finalized.
• Knowwherethesparecarkeysare.
• Ifyouhaveacarecoverwithaninstalledanti–hijack-ing / theft system, like Tracker – know the name and password that you would log into the system with. The emergency call centres also require passwords when contacting you, to ensure the safety of your vehicle and to prove you are the rightful owner. If they have your partner’s cell no / business no. as their first call number for any alerts or queries, you will have to notify them to change the emergency first call contact no. to your own cell no.
• ItwouldbewisetohaveaccesstotheTitleDeedsasthis will show if it should also form part of the Estate (if it’s in your partner’s name it goes into the Estate) or not (if it is in your name, provided you are married with ANC as opposed to Community of Property. Know too if you are married with or without Marital power.)
• MakeityourbusinesstounderstandhowyourMedicalAid (if you have one) works. Notify them straight away that your partner has died, and arrange to become the principal member.
• KnowwhatistobedoneinrespectoftheTAXMAN!When was the last Return submitted (Provisional tax payers submit at different times to regular tax payers) and if you owe SARS money. It would be helpful to know which branch of SARS your partner dealt with. Because E-filing of forms now takes place, there are few, if any physical pages / documents available at your home record. You will need to know the pass-word, and account name information to access SARS extremely secure e-filing system. Know too, who you wouldnominateasyournewTAXADVISOR.
• Makeityourbusinesstoensurethatallthefamilydocumentation is regularly FILED AND UP TO DATE. Things are difficult enough with all the unavoidable required paper work when a person dies.
• Don’tletVehiclelicensesexpireorpolicypremiumslapse. Get a diary and keep tabs on all upcoming deadlines – it is easy to forget day to day stuff when you are preoccupied with all the immediate demands on your time and memory.
• Weeachhavestrengthsofourown,whichwebringtoour marriage, be wise and SHARE, putting the above sorts of things in place. Now, before you need it, in prepara-tion for that day. DON’T leave everything to your partner.
• AttheveryLEAST,haveoneMasterfile,inwhichall relevant documentation / contact names or nos/ information is recorded and know where the file can be found.
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On 13th July 2015 the Davis Tax Committee released its first report on the proposed amendments to South Africa’s existing estate duty system. This report finally brings to an end years of speculation as to what changes might be made to;
1. a) The manner in which trusts are taxed,
2. b) Whether estate duty tax will be reduced or removed,
3. c) Whether both capital gains tax and estate duty tax will continue to be levied on death,
4. d) Whether retirement annuities can be effectively used to reduce the value of an individual’s estate.
The report looks at the various taxes that fall within the context of this system and I will detail these taxes below. Whilst we now have a fairly good idea as to what to expect it must be noted that this is not the law and no changes should be made until we have absolute certainty as to what changes are going to be implemented. The report is open for public comment until 30th September 2015. Unfortunately, we are already seeing the sensationalising of this report in the media where focus is only on one aspect rather than reading it as a whole.
This article is quite lengthy but it is impossible to sum-marise such a complex topic into one or two pages. Please take the time to read through my article as it will provide an insight into the proposed amendments. These amend-ments are sweeping by nature and they will have an impact on any estate plan, be it simple or complex. The Davis Tax Committee report is not just restricted to how trusts will be taxed but also looks at other aspects such as bequests to spouses, retirement funds and capital gains tax.
Trusts:
The only change that has been proposed with regards to trusts is the removal of the “attribution principles” as defined in section 7 as well as section 25B. These two sections allowed the trust to pass through any taxable income to one or more natural persons for the income
to be taxed in their hands. This will have income tax implications as the trust will now be taxed as a separate taxpayer at its flat rate. It has been proposed that this flat rate should be maintained at its existing levels. An exception to this rule is the taxation of “special trusts” as defined (see the end of this article for the definition). As the repeal of the attribution provisions will have diverse and far-reaching implications the report states that it would be in the interests of equity and certainty that the repeal of the attribution provisions be announced in the 2015 National Budget Speech but only be implemented with effect from 1 March 2016. An extensive consultative process will have to follow during the 2015 legislative cycle to identify and address the many issues involved.
Certain important exclusions were specifically mentioned in the report, namely;
1. a) No attempt should be made to force the charging of interest on financial assistance or loans made to a trust:
“There would be numerous complexities associated with implementing a form of transfer pricing adjustment to deem a return on interest-free loans between SA reg-istered trusts and SA taxpayers. The DTC concurs with the recommendations of the Katz Commission that this be avoided.”
1. b) The implementation of Capital Transfer Tax (CTT) and Net Wealth Tax (NWT) has been cautioned against as it was found that these taxes were inefficient and complex and the return generated did not warrant the burden that would be placed on SARS and the taxpayer (see the end of this article for the definition). It looks like these taxes will be shelved.
2. c) The report also clears up the common concern that trusts must be eliminated at all costs. It states;
“taxpayers must be allowed to make use of trusts when it makes sound sense to do so in the pursuit of a commercial benefit. However, as is the case with present company tax rates today, the taxpayer must accept any potential
Davis Tax Committee Estate Duty Report
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adverse tax consequences.
Taxpayers who pursue the postponement of estate duty through the use of trusts will remain at liberty to do so. But upon sale of the assets of a trust a higher rate of tax will be imposed, thus compensating for the estate duty loss.”
If the recommendation regarding the removal of the “attri-bution principles” is accepted there will obviously be a call for taxpayers to be allowed a period to dissolve their existing trust arrangements. The Committee has stated that it is not in favour of this, as:
a) The dissolution of a trust arrangement must be achieved in terms of the provisions of the trust deed, irrespective of tax implications.
b) It would be inequitable to simply allow a trust to “bank” its accumulated estate duty savings.
c) It would be extremely complicated for both SARS and the taxpayer.
Inter-Spouse Bequest, Primary Abate-ment and Estate Duty Rates:
In terms of our current legislation any amount bequeathed to a surviving spouse is free of estate duty tax and capital gains tax (section 4(q) of the Estate Duty Act and para-graph 67 of the 8th Schedule. (See the end of this article for the wording). This means that irrespective of the value that I bequeath to my surviving spouse no estate duty will be triggered. This bequeathing to the spouse is not avoiding tax; it is merely postponing / deferring it until the death of the surviving spouse. However, in this report it appears as if the committee are not in favour of this ability to defer the tax.
“The South African estate duty system contains generous allowances that allow most estates to be subject to both CGT and estate duty only on the death of all spouses. This defers estate duty collection for many years.”
Unlike the Katz Commission that recommended that bequests in favour of spouses remain exempt from estate duty the Davis Tax Committee has recommended that;
“The principle of inter-spouse exemptions and roll-overs should be either withdrawn completely, or subjected to a specified limit.”
The report has made the following recommendations;
It is suggested that the answer may lie in reframing the “portable spouse” abatement. Currently the deceased estate (second dying) is permitted to increase the basic abatement by the unutilised portion of the primary abate-ment of any pre-deceased spouse (first dying). In other words, if the surviving spouse inherited some or all of the first dying spouse’s abatement then this amount can be added to his / her primary abatement. Example, if the surviving spouse inherited the entire estate of the first dying then that spouse would have a tax free estate of R7 million (R3,5 million x 2).(underlined is my emphasis).
If the inter-spouse abatement is withdrawn (currently known as section 4(q)) then it may be possible to advance the primary abatement of the surviving spouse(s) (currently R3,5 million) to be offset in the estate duty computation of the first deceased spouse (thereby giving the first dying a tax free estate of 2 x R3,5 million = R7 million). The estate of the surviving spouse would ultimately forfeit some or all of the primary abatement in the future. The surviving spouse can elect to ‘pass’ his/her primary abatement. In essence this is almost a reversal of what is practised today.(underlined is my emphasis).
This would effectively ensure that no estate duty is imposed until the basic abatement of all spouses has been exhausted. This recommendation would prevent the levels of abuse inherent in the existing unlimited inter-spouse abatement without imposing undue hardship on the surviving spouse.
The negative result of this recommendation is the potential “double taxation” that may occur if a dutiable bequest is received by a surviving spouse who subsequently dies. The effect would be dependent on the length of time that elapses between the deaths of spouses. It is suggested that a simple table could be developed to exclude duti-able inheritances from the estate duty computation of a surviving spouse over a period of up to 10 years.
Given this recommendation, consideration should be given to the repeal of section 4(q) of the Estate Duty Act.(my emphasis)
This section has been used together with section 4(m) of the Estate Duty Act in a well-known and widely used estate plan whereby the estate owner bequeaths the bare dominium of the estate to a family trust subject to a usufruct in favour of the surviving spouse.
Based on this it appears as if the ability to defer estate duty and capital gains tax until the death of the surviving spouse will be removed. This is a massive deviation from what South Africans are used to and the potential for liquid-ity problems within the first dying estate are enormous.
The report does discuss increasing the primary estate duty abatement (currently R3,5 million). Owing to the fact that this amount was last increased effective 1 March 2007 (i.e. 7 years ago) it was felt necessary to re-establish the primary abatement to exclude the effects of fiscal drag between 2007 and 2015. Calculations done by the Com-mittee show that the abatement should have been in the region of R5,7 million by October 2014.
They have recommended that the primary abatement be increased to R6 million per taxpayer and the current flat rate of 20% should remain.
Capital Gains Tax and Estate Duty Tax:
One of the areas of confusion in the past was whether the effective ‘double taxation’ would be removed in the recommendations made by the Committee. As death is a deemed capital gains tax event it was always felt that it was unfair that the taxpayer was taxed twice on death. This report has now given us clarity on this topic.
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Davis Tax Committee Estate Duty Report. Understandably, the initial knee-jerk reactions have all been to express con-cern that structures such as trusts no longer have a place in today’s estate plan. This reaction has also been fuelled by media hype. Whenever changes are made to the taxa-tion of popular structures the media tend to negatively focus on these changes. However; a close examination of what has been proposed does not significantly alter or amend the use of a trust in a planner’s estate plan. In this report sweeping changes have been proposed and it is important that educated decisions be made. When faced with sweeping changes such as what has been proposed the question should always be – what are my options / alternatives?
I have always stated that death duties (deemed capi-tal gains tax, executors’ fees and estate duty tax) are all voluntary taxes. No-one is compelled to structure their affairs in such a way so as to minimise taxes. Every tax-payer is free to plan their estates in whichever way they choose (provided that it is legal). Not everyone requires a trust and every planner should consult with a specialist to determine whether a trust should / could be used in that person’s estate plan.
Under the proposed changes should a taxpayer be happy to pay death duties then he/she can leave his/her assets in their own name and if the value of the estate exceeds R6 million then they will pay estate duty tax at 20%. They will also pay deemed capital gains tax at 13.7% and executors fees at 3.99%. Unfortunately they can no longer defer these duties by bequeathing to the surviving spouse; however the surviving spouse could elect to utilise their primary abatement to mitigate the estate duty tax in the first spouse’s estate.
In the past the taxpayer could have made a large contribu-tion to a retirement fund prior to death but this option no longer exists. Should the taxpayer elect to do so any contribution that did not qualify for a deduction will be included in the gross value of that person’s estate.
The taxpayer could donate his / her (hereafter just referred to as he/ his) estate or a portion thereof to his spouse to remove value from his estate but all he is doing is simply kicking the can down the road until his spouse passes away. Excluded from such donations are immovable prop-erties and shares in companies. The taxpayer also runs the risk that his spouse might decide that she wants a divorce. The problem with gifts are that they are excluded from the calculations to determine how the marital estate is divided with the result that he will be seriously prejudiced if he ever got divorced. The value would be lost when calculating any accrual claim.
A trust can still play a role in an individual’s estate plan-ning exercise. The taxpayer can still transfer assets to a trust via an interest-free loan. The growth will take place outside his estate and he can reduce his loan account on an annual basis. Should he wish to reduce the value of his estate even further he can donate all or a portion of his loan to his spouse. She can then also donate against her loan. He could reduce his loan even further by using dividends received by the trust from its underlying share portfolio or unit trusts. When he dies his loan account
“CGT is widely regarded as an income tax on capital income and not a wealth tax. Estate duty and donations tax are wealth taxes. This distinction was clearly reflected in the review of the CGT proposals conducted by the International Monetary Fund in December 2000 (prior to the implementation of CGT on 1 October 2001). This conclusion is confirmed by a recent review of taxes on wealth and transfers of wealth in the European Union.”
The end result is that both taxes will continue to be levied on death.
Retirement Funds:
I have had many discussions with some of my colleagues who have all advocated the use of retirement funds over the use of trusts. It was held that a significant benefit of the retirement fund was the ability to contribute sub-stantial amounts to the fund and such amounts would no longer form part of the individuals’ estate. The benefit of this is that there would be no deemed capital gains tax, executors fees or estate duty tax in the deceased’s estate. The Committee has proposed that this form of estate planning be done away with;
“The practice should be stopped by simply deeming all retirement fund contributions, made on or after 1 March 2015 and disallowed in the determination of taxable income, to be included in the estate duty computation.”
Donations Tax:
Fortunately no changes have been made to the fact that spouses can still donate to each other without triggering donations tax (see the end of this article for the wording of the relevant sections). The report recommends;
“That the inter-spouse donations tax exemptions contained in section 56(1)(a) & (b) be retained, subject to the section 56(1)(b) exemption being amended to exclude all interests in either fixed property or companies.”
It appears that the Committee specifically wants to exclude the ability for spouses to ‘donate’ ownership of fixed property and shares in companies. It is not specified as to whether companies are limited to private or public so we must make the assumption that it includes both. Memberships in Close Corporations would also fall into this exclusion.
The report also discussed the widespread practice of annual waivers of loan accounts between taxpayers and their estate planning mechanisms or families. Paragraph 12(5) of the Eighth Schedule acted as a disincentive to the annual waiver of loan accounts between founders and their trusts. However the provision was deleted with effect from the commencement of the 2014 year of assessment. The successor to paragraph 12(5), namely, paragraph 12A, contains an exemption in subparagraph (6)(b), covering donations as contemplated in section 55 or section 58. The net result is that the practice of the annual waiver of loan accounts has been allowed to continue.
This concludes my summary of what was written in the
ST13 2015 11
will not attract any capital gains tax. In the past he could have deferred his estate duty by bequeathing the residue of his estate to his spouse. This was merely a deferral and not an avoidance of estate duty tax. When his spouse passed away the value of her estate would have been subject to tax. As this option no longer exists he can now bequeath directly to his trust. R6 million will be free from estate duty tax and the rest will be subject to tax at 20%. Now the assets are out of any natural person’s name and are held in a perpetual entity. The only downside, the taxpayer pays capital gains tax at twice the maximum rate and income tax at 41%. That said, the capital gains tax is elective and the trustees can manage and control when they want to trigger it. The bonus is that because the trust is paying the tax any amounts net of tax will be capital. Should he require funds from the trust the trust-ees can either use this capital to repay his loan account thereby reducing it even faster or they can distribute tax free capital to the taxpayer. The faster he repays his loan the less executor’s fees and estate duty tax he will pay one day. He can also still use his trust to transfer wealth to his children without triggering donations tax. If the taxpayer wanted to transfer wealth to a child he would be restricted to the annual amount of R100,000. The trust can distribute as much as the trustees want to.
As I said in the beginning, trusts are not for everyone. They are not the silver bullet that will end all evils but they are also not the pariah that they are sometimes made out to be. They are a tool that can be utilised in an individual’s elective estate plan. They can operate in isolation or in conjunction with other estate planning structures.
EXPLANATIONOFTERMS
1. Definition of a “Special Trust”.
A “special trust” means a trust created—
(a) solely for the benefit of one or more persons who is or are persons with a disability as defined where such disability incapacitates such person or persons from earning sufficient income for their maintenance, or from managing their own financial affairs: Provided that—
(aa) such trust shall be deemed not to be a special trust in respect of years of assessment ending on or after the date on which all such persons are deceased; and
(bb) where such trust is created for the benefit of more than one person, all persons for whose benefit the trust is created must be relatives in relation to each other; or
(b) by or in terms of the will of a deceased person, solely for the benefit of beneficiaries who are relatives in relation to that deceased person and who are alive on the date of death of that deceased person (including any beneficiary who has been conceived but not yet born on that date), where the youngest of those beneficiaries is on the last day of the year of assessment of that trust under the age of 18 years;
2. Capital Transfer Tax: (CTT) is a more advanced and sophisticated form of inheritance tax than estate duty that seeks to impose taxation periodically instead of only on death. In particular, CTT seeks to recover lost estate duty collections where assets have been transferred into trusts.
3. Net Wealth Tax: (NWT) is an annual or periodic tax. NWTs are applied to taxpayers with a large surplus wealth.
4. Section 4 Estate Duty Act: The net value of any estate shall be determined by making the follow-ing deductions from the total value of all property included therein:
(q) so much of the value of any property included in the estate which has not been allowed as a deduction under the foregoing provisions of this section, as accrues to the surviving spouse of the deceased.
5. Paragraph 67: Transfer of asset between spouses.—
(1) (a) , a person (hereinafter referred to as “the trans-feror”) must disregard any capital gain or capital loss determined in respect of the disposal of an asset to his or her spouse (hereinafter referred to as “the transferee”).
6. Donations tax shall not be payable in respect of the value of any property which is disposed of under a donation—
(a) to or for the benefit of the spouse of the donor under a duly registered antenuptial or post-nuptial contract or under a notarial contract entered into as contemplated in section 21 of the Matrimonial Property Act, 1984 (Act No. 88 of 1984);
(b) to or for the benefit of the spouse of the donor who is not separated from him under a judicial order or notarial deed of separation;
ST13 2015 12
Diversification is regarded as an important concept by most investors. Done correctly, it can help provide greater certainty of growth in real returns, and some describe diversification as “the only free lunch in finance”.
However, the simple phrase disguises a complex concept. Rather than simply owning lots of different assets, it is important to understand the fundamental drivers of assets, how assets are likely to behave and the role they can play, in order to build a properly diversified portfolio. Simply owning “different” assets without understanding their behaviours under different scenarios can lead to disappointment.
In this article, we draw from our learnings and experiences of successfully managing total return multi-asset portfolios for over 20 years to discuss the topic of diversification. We start off by briefly re-stating the arguments for taking a diversified approach. We then talk about the miscon-ceptions or fallacies around the concept of diversification that we have identified. Finally, we touch on our approach to building diversified portfolios.
How does diversification work and why is it so important?
Diversification is the principle of spreading wealth across a number of different investments, with the objective of providing a desired level of return with as little risk as pos-sible. The theory is simple – combining investments that exhibit different return patterns means that large fluctua-tions seen in individual investments can be smoothed out, leading to a better overall outcome than holding just one of the assets in isolation.
Why is it so important to reduce risk? Greater risk means greater uncertainty, which most investors dislike. By reduc-ing risk, investors may have greater confidence in achiev-ing specific goals, such as the growth of capital in real terms, by narrowing the range of potential outcomes they are facing. This is as true for individual investors as it is for large corporates, or retirement funds.
The practice of finding investments that exhibit different behaviours to each other and combining them in a way that delivers an enhanced risk-adjusted return is harder than the theory might suggest. The next section deals in particular with some of the reasons why this is the case.
The three fallacies of diversification
There has often been a gap between the perception of what ‘diversification’ should bring and the reality of what it has achieved. We have identified three fallacies around the concept of diversification.
Fallacy #1: Lots of colours on a pie = diversification
There are some approaches that hold out that they are diversified purely on the basis that they invest in a number of different positions. Indeed, this illusion of diversification is typically propagated by showing the portfolio using a pie chart, with many different colours.
In practice, however, these portfolios are often loaded with assets with common fundamental drivers, for exam-ple equities, with each colour used to describe a different equity segment rather than distinct assets with differing fundamental drivers. However, as noted above, potential diversification benefits are negated in instances where
Diversification
Lesley HohneDirector
ST13 2015 13
there is commonality in the fundamental return drivers prevalent. Therefore, a portfolio loaded with equities will leave the benefits from ‘diversification’ as limited at best. Investors should be cautious about assuming that products with the word ‘Diversified’ in their name and that show lots of pretty colours on a pie chart are actually diversified.
Breadth of holdings alone does not guarantee diversi-fication. Rather, it is important to assess the underlying characteristics of assets and build a portfolio with a mix of return drivers.
Fallacy #2: Asset class labels accurately describe their behaviour
Market convention suggests that ‘bonds’ should behave differently to ‘equities’, and ‘alternatives’ should behave differently to both bonds and equities. However, we believe this convention is overly simplistic, inaccurate and dangerous. There are certain assets tagged as a ‘bond’ that actually behave more like ‘equity’, and certain assets tagged as ‘alternatives’ that do not behave differently to either equities or bonds.
We therefore believe it is important to examine the under-lying behaviours of asset classes in determining their role within a portfolio, rather than just rely on labels. There is an old saying, the so-called ‘duck test,’ which suggests “if it looks like a duck, walks like a duck and quacks like a duck…then the chances are that it is a duck”. The sentiment behind this saying is useful in determining the behaviour of assets in our view. Just because a high yield bond, for example, is classified as a bond it does not mean it has to be considered as such. We would prefer to treat it like an equity based on the way that it “walks and talks”.
Fallacy #3: Asset relationships are constant over time
The final fallacy we have identified relates to the view that the historical behaviour of assets to one another cannot be relied upon to determine how they will behave in the future. For example, it is assumed government bonds are always negatively correlated to equities, or that emerg-ing market bonds have a low correlation to equities. However, it is our view that asset relationships can vary significantly over time.
We believe that the behaviours of assets require continuous evaluation in order to better determine the optimal role they can play in the diversification of portfolios.
Our approach to diversification
The core aspect of our approach to diversification is to focus on asset behaviours rather than their labels when building portfolios. When assessing opportunities and determining their role in a portfolio, we do not think in terms of ‘equities’, ‘bonds’ and ‘alternatives’, but rather three distinct categories of ‘Growth’, ‘Defensive’ and ‘Uncorrelated’ assets.
Growth assets have returns which are directly related to expectations of real economic growth, and react posi-tively to overall risk appetite. Equities, as well as assets
conventionally regarded as bonds or alternatives such as high yield bonds, emerging market debt, property and certain commodities are included in this category.
Defensive assets react positively to declining expecta-tions of real economic growth, and should provide safe havens in market crises. Developed market government bonds, index-linked bonds and hedging/protection strate-gies reside in this category.
Uncorrelated assets have a variable relationship with growth and risk appetite, with performance generally unrelated to real economic growth. Examples include gold, infrastructure and reinsurance.
In addition, we also take active currency positions, which can be regarded as either Growth, Defensive or Uncor-related depending on their nature.
Owning an optimal mix of Growth, Defensive and Uncorrelated assets goes a long way to achieving superior diversification. However there is one additional aspect that needs to be considered – ensuring that alloca-tions are sized appropriately. Any potential diversification benefits would be negated if, for example, a portfolio was comprised of 95% capital in Growth assets, 3% in Defensive assets and 2% in uncorrelated assets.
In ensuring appropriate diversification, we believe it is important to think about individual positions in respect to how risky they are – both on a stand-alone basis and in relation to how they interact with other positions. We test the impact of positions on the overall risk of the portfolio prior to inclusion, which allows us to calibrate their size accordingly. Secondly, we will vary the sizing of individual positions, and the overall split between Growth, Defensive and Uncorrelated assets, over the course of a cycle.
Diversification, if applied correctly, can substantially improve outcomes for investors and should lie at the heart of a multi-asset approach. However, in our view, many ‘diversified’ approaches have not delivered to expectations in the past, with some common reasons to blame. Understanding the common misconceptions and investing wisely in a truly diversified fashion demands insight, experience and patience, both of the investment manager and investors.
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Page
1 o
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ST13 2015 14
Fund
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l Cap
ZAR
-1.9
%0.
8%3.
6%3.
6%6.
7%14
.9%
16.3
%15
.0%
6.5%
7.5%
13.7
%SA
Inte
rest
Bea
ring
- Mon
ey M
arke
tZA
R0.
5%0.
9%2.
1%2.
1%5.
0%5.
1%5.
3%7.
0%0.
2%0.
2%0.
6%SA
Inte
rest
Bea
ring
- Sho
rt T
erm
ZAR
0.5%
1.4%
3.0%
3.0%
5.6%
5.6%
5.8%
7.0%
0.5%
0.4%
0.8%
SA In
tere
st B
earin
g - V
aria
ble
Term
ZAR
-0.2
%-0
.8%
1.2%
1.2%
6.1%
6.2%
8.3%
7.7%
6.6%
6.0%
5.9%
SA M
ulti
Asse
t - F
lexi
ble
ZAR
-1.2
%0.
1%5.
2%5.
2%7.
9%14
.7%
13.7
%13
.0%
5.4%
5.8%
7.8%
SA M
ulti
Asse
t - H
igh
Equi
tyZA
R-1
.1%
0.1%
4.7%
4.7%
7.5%
14.3
%13
.0%
12.4
%5.
5%5.
5%7.
6%SA
Mul
ti As
set -
Inco
me
ZAR
0.5%
1.4%
3.3%
3.3%
5.4%
6.4%
6.9%
7.8%
1.5%
1.4%
1.6%
SA M
ulti
Asse
t - L
ow e
quity
ZAR
-0.5
%0.
4%3.
8%3.
8%7.
2%10
.6%
10.1
%9.
9%3.
2%2.
9%3.
8%SA
Mul
ti As
set -
Med
ium
Equ
ityZA
R-0
.9%
0.1%
4.2%
4.2%
7.2%
13.0
%12
.0%
11.3
%4.
6%4.
6%6.
5%SA
Rea
l Est
ate
- Gen
eral
ZAR
-1.4
%-5
.5%
6.2%
6.2%
25.3
%17
.7%
18.6
%18
.1%
13.9
%11
.8%
15.0
%SA
Wor
ldw
ide
Mul
ti As
set F
lexi
ble
ZAR
-1.1
%1.
4%7.
5%7.
5%13
.5%
20.3
%16
.5%
12.7
%7.
8%7.
0%8.
1%
Glob
al E
quity
- Ge
nera
lZA
R-1
.1%
2.2%
9.4%
9.4%
15.0
%28
.2%
20.4
%10
.8%
12.4
%12
.4%
12.7
%Gl
obal
Inte
rest
Bea
ring
- Sho
rt T
erm
ZAR
0.7%
1.5%
5.3%
5.3%
12.4
%12
.8%
9.4%
6.5%
11.1
%13
.1%
14.2
%Gl
obal
Inte
rest
Bea
ring
- Var
iabl
e Te
rmZA
R-0
.5%
-1.2
%1.
5%1.
5%5.
5%12
.3%
10.7
%8.
7%9.
7%11
.9%
13.3
%Gl
obal
Mul
ti As
set -
Fle
xibl
eZA
R-0
.6%
1.8%
6.7%
6.7%
11.3
%22
.0%
16.1
%9.
7%11
.2%
11.1
%11
.0%
Glob
al M
ulti
Asse
t - In
com
eZA
R0.
8%1.
7%5.
9%5.
9%13
.2%
13.1
%10
.8%
8.7%
7.2%
8.0%
8.6%
Glob
al M
ulti
Asse
t - L
ow e
quity
ZAR
-1.5
%-0
.7%
5.1%
5.1%
14.3
%18
.3%
12.8
%8.
7%11
.2%
12.9
%12
.6%
Glob
al R
eal E
stat
e - G
ener
alZA
R-3
.9%
-6.2
%1.
5%1.
5%12
.7%
22.3
%20
.6%
9.8%
11.1
%11
.1%
17.3
%1 V
olat
ility
is a
stat
istic
al m
easu
re th
at p
rovi
des a
n in
dica
tion
of th
e di
sper
sion
of re
turn
s ove
r tim
e
Disc
laim
er: U
sers
shou
ld b
e aw
are
that
shor
t ter
m p
erfo
rman
ce ca
n be
vol
atile
and
that
pas
t per
form
ance
is n
ot n
eces
saril
y a
good
gui
de to
futu
re p
erfo
rman
ce. T
he in
form
atio
n in
this
repo
rt is
for g
ener
al g
uida
nce
and
does
not
cons
titut
e an
offe
r mad
e by
Fun
dhou
se.
This
repo
rt is
for t
he u
se o
f Fun
dhou
se a
nd it
s cl
ient
s on
ly a
nd m
ay n
ot b
e pu
blish
ed e
xter
nally
with
out p
erm
issio
n fir
st b
eing
obt
aine
d fr
om F
undh
ouse
. Whi
le g
reat
car
e an
d di
ligen
ce h
as b
een
take
n in
the
com
pila
tion
of th
e re
port
with
Dat
a pr
ovid
ed b
y Pr
ofile
Data
an
d FE
, no
repr
esen
tatio
n or
war
rant
y, e
xpre
ss o
r im
plie
d, is
or w
ill b
e gi
ven
by F
undh
ouse
or i
ts d
irect
ors,
par
tner
s, e
mpl
oyee
s or a
dvise
rs o
r any
oth
er p
erso
n to
the
accu
racy
or t
he c
ompl
eten
ess o
f the
info
rmat
ion
in th
e re
port
or r
elat
ing
ther
eto.
Fun
dhou
se w
ill n
ot
acce
pt a
ny li
abili
ty fo
r los
ses s
uffe
red
as a
resu
lt of
inac
cura
cies
. D
ata
supp
lied
by P
rofil
e Da
ta A
naly
tics
|
ww
w.fu
ndho
use.
co.za
Page
2 o
f 3
ST13 2015 15
Fund
hous
e Ad
vise
r Mar
ket R
epor
t: 30
June
201
5Se
ctio
n 3:
Cha
rts
2 Cal
cula
ted
as 5
3% S
A Eq
uity
, 14.
5% S
A Bo
nds,
7.5%
SA
Cash
5%
SA
Prop
erty
, 12
% G
loba
l Equ
ity, 8
% G
loba
l Bon
ds a
fter
1 Ju
ly 2
011,
and
56.
5% S
A Eq
uity
, 15.
5% S
A Bo
nds,
8% S
A Ca
sh 5
% S
A Pr
oper
ty,
9% G
loba
l Equ
ity,
6% G
loba
l Bon
ds p
rior t
o 1
July
201
1.
5.6%
16.2
%15
.7%
15.1
%
5.2%
19.1
%18
.1%
17.2
%11
.6%
12.6
%12
.4%
13.1
%
0%10%
20%
30%
1yr
3yr p
a5y
r pa
10yr
pa
SA G
ener
al E
quity
Fun
ds
SA E
quity
- Ge
nera
lFT
SE/J
SE A
ll Sh
are
Inde
x (A
LSI)
SA In
flatio
n +
7%p.
a
7.5%
14.3
%13
.0%
12.4
%
8.1%
17.2
%16
.6%
15.0
%
9.6%
10.6
%10
.4%
11.1
%
0%10%
20%
1yr
3yr p
a5y
r pa
10yr
pa
SA B
alan
ced
Fund
s
SA M
ulti
Asse
t - H
igh
Equi
tyBa
lanc
ed B
ench
mar
kSA
Infla
tion
+ 5%
p.a
5.0
10.
0
15.
0
20.
0
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
PE Ratio
JSE
All S
hare
: PE
Rat
io o
ver 2
0 Ye
ars
AVE:
14.
76
-
2.0
4.0
6.0
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Dividend Yield
JSE
All S
hare
: Di
vide
nd Y
ield
ove
r 20
Year
s
AVE:
2.
73
0%10%
20%
30%
40%
50% Ja
n 04Ju
l 04Ja
n 05Ju
l 05Ja
n 06Ju
l 06Ja
n 07Ju
l 07Ja
n 08Ju
l 08Ja
n 09Ju
l 09Ja
n 10Ju
l 10Ja
n 11Ju
l 11Ja
n 12Ju
l 12Ja
n 13Ju
l 13Ja
n 14Ju
l 14Ja
n 15
SA M
arke
t Ret
urns
: 3y
r Rol
ling
Retu
rns v
s In
flatio
nSA
Bon
dsSA
Equ
ities
SA C
ash
SA In
flatio
n2
Disc
laim
er: U
sers
shou
ld b
e aw
are
that
shor
t ter
m p
erfo
rman
ce ca
n be
vol
atile
and
that
pas
t per
form
ance
is n
ot n
eces
saril
y a
good
gui
de to
futu
re p
erfo
rman
ce. T
he in
form
atio
n in
this
repo
rt is
for g
ener
al g
uida
nce
and
does
not
cons
titut
e an
offe
r mad
e by
Fun
dhou
se.
This
repo
rt is
for t
he u
se o
f Fun
dhou
se a
nd it
s cl
ient
s on
ly a
nd m
ay n
ot b
e pu
blish
ed e
xter
nally
with
out p
erm
issio
n fir
st b
eing
obt
aine
d fr
om F
undh
ouse
. Whi
le g
reat
car
e an
d di
ligen
ce h
as b
een
take
n in
the
com
pila
tion
of th
e re
port
with
Dat
a pr
ovid
ed b
y Pr
ofile
Data
an
d FE
, no
repr
esen
tatio
n or
war
rant
y, e
xpre
ss o
r im
plie
d, is
or w
ill b
e gi
ven
by F
undh
ouse
or i
ts d
irect
ors,
par
tner
s, e
mpl
oyee
s or a
dvise
rs o
r any
oth
er p
erso
n to
the
accu
racy
or t
he c
ompl
eten
ess o
f the
info
rmat
ion
in th
e re
port
or r
elat
ing
ther
eto.
Fun
dhou
se w
ill n
ot
acce
pt a
ny li
abili
ty fo
r los
ses s
uffe
red
as a
resu
lt of
inac
cura
cies
. D
ata
supp
lied
by P
rofil
e Da
ta A
naly
tics
|
ww
w.fu
ndho
use.
co.za
Page
3 o
f 3
ST13 2015 16
ST13 2015 17
Sterling Private Wealth (Pty) LtdGround Floor, Block B, 19 Impala Road, ChislehurstonPrivateBagX9978,Sandton2146t. 2711 883 8828 f. + 2711 783 0091www.sterlingwealth.co.za
DIRECTORS LS Hohne · GR Morris · JJ Strydom · JdV Guimaraens · RB Gibson
Sterling Private Wealth (Pty) Ltd, Reg. No. 2007/004491/07 FSB Licence No. 32319
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