Eastern Cape's Community... PERSONAL FINANCE A FREE publication distributed by NFB Private Wealth Management private wealth management Issue 18 July 2011 NFB PERSONAL FINANCE Magazine Eastern Cape's Community... see inside for details WIN A WEEKEND STAY AT BUSHMAN SANDS Forming a base case scenario on which to base future expectations of investment returns YOUR FINANCIAL ADVISOR Is he/she “fit & proper”? RISK AND LIFE INSURANCE A necessary evil or an investment in peace of mind? CRYSTAL BALL?
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Eastern Cape's Community...
PERSONAL FINANCE
A FREE publicationdistributed by NFB Private Wealth Management
p r i v a t e w e a l t h m a n a g e m e n t
Issue 18July 2011
NFB
PERSONAL FINANCEMagazine
Eastern Cape's Community...
see inside for details
WIN A WEEKEND STAY ATBUSHMAN SANDS
Forming a base casescenario on which to base
future expectations ofinvestment returns
YOURFINANCIALADVISOR
Is he/she “fit &proper”?
RISK AND LIFEINSURANCEA necessaryevil or aninvestment inpeace ofmind?
CRYSTAL BALL?
“The best way of preparing for the future is to takegood care of the present, because we know that ifthe present is made up of the past, then the futurewill be made up of the present.
Only the present is within our reach. To care forthe present is to care for the future.”
What does it mean that they are “fitand proper”? By -
NFB, East London.Robyne Moore
YOUR FINANCIAL
ADVISOR
10
THE BASE CASEThis article will breakdown and then rebuild an
investment return in order to gain some insight as
to what we could expect from our investment
portfolios in terms of future returns. Before we get
going, it should be noted that the content to follow
will be based on equity returns in South Africa.
Secondly, there are some inputs that are variable
and, as such, assumptions or analysis needs to take
place alongside these. We would ask that you
apply your own views to these variables and, in so
doing, challenge our thinking.
If you happen to own or pick up some form of
theoretical investment book you are likely to come
across a section describing the components of an
investment return. It is these components that we
will look at individually and then try to decide
whether historical averages are likely to remain
true or, if untrue, whether we have entered a new
phase of economic and investment cycles.
When building an investment return from the
bottom up, we use, based in part on the textbooks
mentioned above, the following components:
Inflation (CPI) – an investment needs to match
CPI to maintain its purchasing power.
Risk Free Rate (STEFI Call Deposit) – this is the
minimum return you would expect from a risk free
asset. In other words: for anything other than risk
free cash you would demand a higher return.
Dividend Yield - it is quite easy to forget the
importance of a dividend yield, alternatively
known as cash flow, but when looking at long term
total returns from equity you will see that the
reinvestment of dividends accounts for the majority
of your overall return.
X-factor – this would be very difficult, if not
impossible, to predict as this is the positive or
negative return enjoyed by investors after
deducting CPI, STEFI and dividend yield from the
total return of the JSE All Share Index. The x-factor is
our complete unknown.
If you take the above 4 factors and add them
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In order to know the outcome of the nextDurban July horse race or which market willperform best over the next year, would it notbe handy to have a crystal ball? I think weall understand that this type of foresight orforecasting is not possible with anysemblance of accuracy. However, we dothink that through the analysis ofhistorical information we may be ableto form some type of base casescenario on which to base futureexpectations of investmentreturns. Unfortunately, wecannot help with horses!Written by StephenKatzenellenbogen, NFBGauteng, Private WealthManager
sensible finance july11
CRYSTAL BALL?CRYSTAL BALL?
together you should then get the total return on the
All Share Index for the corresponding period. This
works better for longer-term periods (i.e. ten years)
than it does for shorter periods.
The average inflation rate, using CPI, for the
last ten years has been 5.84%. This should also be
placed in the context of the South African Reserve
Bank's target range of 3% - 6%. Inflation has a vast
number of interrelated components than can
positively or negatively affect the final number. We
will not make an attempt at predicting these
variables, but rather give a broad synopsis. We do
think that the Reserve Bank will, on average, keep
inflation within the target range. It is also likely that
global authorities will continue to pursue a positive,
but controlled inflation environment, thus
impacting South Africa's inflation environment.
The above graph depicts the downward trend
in interest rates. We do think that going forward we
will continue to be in a lower interest rate, and
lower inflation rate, environment. As such, the ten
year risk free return, measured by the STEFI Call
Deposit rate of 8.93%, is likely to average down
over time.
When you buy a share you are buying a part of
that particular business and, as such, will
participate in the profits and losses of that entity. If
a business has excess profits it can either apply
these within the business to fund future expansion
projects or, alternatively, these profits can be
distributed to shareholders in the form of a
dividend. Very often a combination of these
options is used and shareholders enjoy a dividend
to reward them as loyal owners of the company.
We have discussed the importance of dividend
reinvestment and long term returns and, as such, it
is worth noting that the average dividend yield of
the JSE All Share Index over the last ten years has
been 3.49%.
(We must not forget that a quality company
may not always pay a dividend, with Anglo
American being top of mind during 2010).
We mentioned above that the final and fourth
component of total equity return is:
JSE ALSI Total Return minus (inflation + risk-free
rate+ dividend yield)
The net result of this sum gives us an average
ONE STEP AT A TIME
X-FACTOR
INFLATION
RISK FREE RATE
DIVIDEND YIELD
SENSIBLE INVESTOR
11sensible finance july11
continued overleaf...
return of -1.61% over the last 10 years.
Let us begin by looking at a graphical
representation combining the different
components of investment return.
At a glance we can see that historically both
the dividend yield and risk-free rate have been
positive, with inflation and the x-factor moving
between positive and negative territory.
The average yield of the above components
can be summarized as follows:
Risk Free Rate (STEFI Call Deposit) 8.93%
Inflation (SA CPI) 5.84%
Dividend Yield (JSE All Share Index) 3.49%
X-Factor (JSE Total Return minus CPI,
STEFI & Dividend Yield) -1.61%
What we have achieved so far is identifying,
describing and quantifying the different
components of total return. The next and final step
is to determine how this affects us as investors. For
the purposes of our discussion let us assume the
following going forward:
Inflation 4.5% This is in the middle of the
target range
Risk Free rate 6.5% Common belief is for
interest rates to
remain lower than those
enjoyed historically
Dividend Yield 3% Increased competition
may lead to lower profits
X-Factor 0% We have given this the
benefit of the doubt
against its historical track
record of -1.61%
Due to a lack of space please forgive us for
making some assumptions with little explanation in
'Table 2'. Nevertheless, if we can in principal agree
with these numbers we then could expect long
term returns to be around 2.6% lower than those
enjoyed historically. Put another way, future
expected returns could be approximately 15.5%
lower than historical averages.
Throughout this article we have focused on equity
returns. A balanced portfolio should have a blend
of cash, bonds, property and equity in accordance
with the appropriate risk-profile. Expected returns
would thus need to be modified based on the
overall asset allocation. In some instances you may
have inflation plus (e.g. CPI + 5%) targets and can
adjust your sights accordingly.
An unfortunate consequence of a lower return
environment is the need to save additional funds
for retirement or other investment goals. Always
remember to, as far have possible, have a well
thought out investment plan constructed in
conjunction with a professional advisor to ensure
prosperity and peace of mind.
WHAT IS THE 'BOTTOM LINE'?
THE END GAMETable 1
AVERAGE TOTAL RETURN 16.65%
Table 2:
TOTAL 14%
*All graphs courtesy of NFB Asset Management
12 sensible finance july11
SENSIBLE INVESTOR
...continued from page 10
CRYSTAL BALL?CRYSTAL BALL?
13
SENSIBLE PLANNING
The phrase "testamentary freedom", i.e. the
freedom to leave your property to whomever
you wish in your Will, is well known, but what
can you do if you have been written out of a Will or
want to challenge the wishes of a recently
departed family member?
It is surprisingly common for individuals to try to
disinherit their families and leave it all to the
proverbial cats' home. The more unusual cases
make the papers – remember the case of Golda
Bechal, an 88-year-old widow living in the UK,
whose relatives challenged her Will after she left
most of her £10m fortune to the owners of her
favourite Chinese restaurant.
As people are now living longer many often
decide to change their Wills later in life without the
assistance of a professional. This can lead to family
members suspecting foul play if they have been
written out of the Will. Challenges to Wills are costly
and difficult to win, not least because the principal
party one might want to obtain evidence from is
no longer with us!
Legally-speaking, it is possible to challenge a
Will for one or more of the following reasons:
Lack of proper formalities
Lack of testamentary capacity
Lack of knowledge and approval
Undue influence and fraud
A Will must be made in writing, preferably not
handwritten, and signed by the testator on every
page, in the presence of two witnesses who must
each also attest and sign the Will in the presence
of the testator. If any of these requirements are
missing the Will is invalid.
To make a valid Will the testator must have the
requisite mental capacity. The testator must be
capable of understanding that they are making a
Will and disposing of their assets on death. The
testator must also be capable of understanding
the extent of their estate and appreciate the
claims on that estate to which he ought to give
effect.
The difficulty with proving this ground is that
you must produce evidence of the testator's
capacity after their death. When a Will is drawn up
by a professional and if there are doubts about a
person's capacity, the professional should ask a
doctor to assess capacity before a Will is made.
A testator must know and approve the contents of
the Will. If a Will has been properly executed, it is
presumed that the Will is valid on this ground and,
generally-speaking, you will have to prove (on the
balance of probabilities) that the testator did not
know and approve the contents of the Will.
A presumption of Undue Influence usually arises
when the beneficiary had actively participated in
the preparation and execution of the Will and had
disproportionately benefited from it. Undue
influence means coercion, but no physical force is
necessary. This is not the same as persuasion.
Reminding the testator of their family obligations or
what you have done for them in the past is not
undue influence. It is essentially down to the person
alleging undue influence to show that the testator
was coerced into making the Will. Given that the
testator is no longer around and that they have
often been isolated by the person against whom
undue influence is alleged, it is one of the most
difficult allegations to sustain - there may be lots of
suspicion, but relatively little hard evidence!
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Lack of proper formalities
Lack of testamentary capacity
Lack of knowledge and approval
Undue influence and fraud
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