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Seed Weekly - Targeting Returns

In financial planning, targeting a return is a very specific and individual thing and each investor has a different set of circumstances affecting them. As an adviser and investment manager I have tried over the years to blend the needs of the investor with the available tools and skills to provide a satisfying solution.

I was recently presented with an interesting challenge by a serious investor, in this case the investor was not asking for the near impossible i.e. I have too little capital so I am looking for very high growth with low volatility. It was an exercise of asset and liability matching for retirement.

The investor had adequate capital to fund their retirement needs at an approximate inflation plus 3% p.a. return profile. The challenge was that retirement was 9 years away. The investor was prepared to take on more risk to achieve excess capital growth over the intervening nine years and had in fact signed a mandate to do so. However, given all of the current and possible future social, political and economic unrest and uncertainty, how do you implement a high growth strategy with low volatility and capital security at retirement? So as not to confuse you, the funds were discretionary i.e. outside of a retirement fund structure and thus would be subject to income tax and capital gains tax on returns.

The original advice had been to go into a blend of balanced multi-asset high equity funds and several alternatives options had included a target return fund of inflation plus 3% p.a. What the investor was looking for was a gradual process of increasing volatility from 1% to approximately 6% and then holding it there until three years prior to retirement date.

The “gradual in” process is not the difficult part. The concept of rand cost averaging into the higher volatility investments is not new, however the challenge lied in de-risking the portfolio closer to retirement. It required an active asset allocation decision at some point. These tactical decisions are better left to investment professionals rather than financial planners, but even professionals can get it wrong.

There are many negative “What if’s” to consider, what if there is a financial crisis 3-4 years prior to retirement and could the investor lose 10-20% of accumulated capital in a short period and not recover it in time for retirement? What if traditional high growth assets such as equities and properties do not deliver the high returns of the past in a new “low growth” environment, would it be worth taking the risk? To name but a few.

We designed a few scenarios and aimed at offering a “most probable outcome” scenario based on asset allocation and diversification, we took into account the very expensive local equity market PE’s, the likelihood of stable high real interest rates, the increasing global government debt burden, along with many other factors and realised that if you do not need to take capital risk don’t. Rather optimise your planning by using sustainable planning tools to minimise the tax burdens and invest only excess returns in growth assets. Below is a graph of the model selected and the risk statistics attached.

Source: Seed, Zephyr (10 November 2016)

* Illustration above is using a R1m investor investing 10 years ago, using actual historical performance numbers (after all investment, platform & advisor fees). Risk & Return statistics are annualised over the 10-year investment period where applicable.

Source: Seed, Zephyr (10 November 2016)

This way the investor and the adviser sleep easier and still participate in the upside, getting the much sought after free lunch so to speak.

We are not all as disciplined and or as fortunate as my new client to have built up sufficient capital not to take excess risk when you can least afford it, however if you are in a similar position I would consider following this course of action.

Kind regards,

Robert Foster

Tel +27 21 914 4966
Fax +27 21 914 4912
Email info@seedinvestments.co.za

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Fri, 11 Nov 2016- 08:46



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