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Introduction

Our investment strategy is to only invest in products which are strictly regulated by the Financial Services Board (‘FSB’), the Association of Savings and Investments in South Africa (‘ASISA’), the Collective Investment Schemes Control Act (‘CISCA’), the South African Reserve Bank (‘SARB’), and the South African Revenue Services (‘SARS’).

This gives us and our clients more peace of mind than with investments which are not so heavily regulated, for example property syndications.

Reasons why we use unit trusts as investment vehicles

  1. Performance reporting: 
    The CISCA has various levels of disclosure in reporting, including the legal obligation for management companies to release performance statistics and details of underlying investments to the public on a quarterly basis.
  2. Transparency:
    Unit trusts are more “transparent” than other investment vehicles (endowment policies) and the level of disclosure required from managers have increased with the promulgation of the CISCA. Fund managers must disclose all the charges that are levied, when they will be levied, exactly how the manager will repurchase participatory interests, particulars of the historical yield and details of any profits that were distributed during the previous financial year.
  3. Accessibility:
    Investors can either invest a lump sum or contribute regularly via debit orders. Minimum lump sums vary from R5,000 to R20,000 and minimum debit orders can be as low as R200 per month.
  4. Tax effeciency:
    Income (interest and dividends) and capital gains on unit trusts are taxed in the hands of the individual investor, not the unit trust itself. Unit trust companies provide statements to investors on an annual basis to reflect all transactions for tax purposes, and this reduces the burden on individuals to do these calculations themselves.
  5. Professional management:
    Investors in unit trusts entrust the task of portfolio monitoring to professional fund managers who charge asset management fees. Annual fees are usually less for income and index funds as for equity funds and multi-manager funds are usually the most expensive ones.
  6. Competitive cost structure:
    The entry costs and management cost charges have to be fully disclosed, and investors can therefore eliminate fund managers who charge exorbitant fees on their investments.
  7. Convenience and liquidity:
    Unit trusts are easy to buy and sell. Debit orders can be cancelled, increased, or decreased without penalty, unlike traditional insurance savings. Investors can change their asset allocation as their personal circumstances change – you can switch from equity based investments to fixed interest investments within a few days of giving instructions.

Most importantly, management companies are obliged to repurchase participatory interests on demand, making unit trusts highly liquid. However, the flexibility and transaction ease can cause investors to react emotionally to volatile market conditions: selling when the market is falling and buying when the market has reached new highs. So while convenience must be seen as an advantage of unit trusts, it does demand of investors that they become more knowledgeable and disciplined in their investment approach.

Important information about unit trusts

Unit trusts should be viewed as medium to long term investments.

The value of the participating interest (‘units’) may increase or decrease and historical performance is not necessarily an indication of future returns. Unit trusts are traded at current prices and can get involved in scrip lending and loans.

Different classes of units may be applicable on these portfolios and is subject to different fees and costs.

Unit trust prices are calculated on a net asset value basis which is the total value of all the assets in the portfolio (including any accumulated income) and less any allowable deductions (broker fees, tax, VAT, audit fees, bank costs, trustee- and safekeeping costs, performance fees and annual management fees) of the portfolio divided by the number of units which has been issued. “Forward pricing” is used.

Investment risks

Individuals invest funds to achieve a return on them, but they often receive less than what they expected. Investment risks are broadly defined as the chance that you will receive less than what you expected from an investment, or that the capital value will be materially less than your original capital value.

Investors differ in terms of their risk appetite, this is the risk that an investor is willing to take or is comfortable with with the hope of achieving higher returns. Investors who are risk-averse do not want to take too much or any risks and they will invest in a money market fund or a fixed deposit account at a bank. In return for this low or no risk they will also achieve a low return on their investment.

On the other side of the spectrum there are investments, like options, where risk-seeking investors can double their investments within a very short period of time. Or they can lose the entire capital value (and even more).

A risk-averse investor only sees the anticipated return without any regard for the risk which is associated with the investment.

Types of investment risks

  1. Systematic risk:
    Caused by different factors, or which influences different investments in different ways.
  2. Non-systematic risk:
    Risks that only influence a certain part of the economy or risks which is specific to a type of business or asset. These risks can be decreased through diversification.
  3. Inflation risk:
    Systematic risk which decreases real returns as result of the decreasing purchase power of returns. Even though inflation influences the most investment returns negatively, exchange rate inflation will result in higher returns, like when it is sold in an exchange rate transaction.
  4. Interest rate risk:
    Risk which decreases returns due to changes in the interest rate environment. Interest rate risk can influence different investments in different ways. The price of government bonds in the secondary market change inversely to interest rates, when interest rates rise the price of government bonds decreases, and vice versa.
  5. Business risk:
    Risk which can decrease the value of a company’s net assets or net income, which will reduce the return on any security which is based on these assets. Some business risks are sector risks which can influence every company in a specific sector, while some business risks only influence a specific company.
  6. Financial risk:
    Risk that a company cannot pay its creditors due to a high debt liability. Interest and capital then has to be paid on borrowed funds and failure to pay it can result in the company being declared bankrupt.
  7. Tax risk:
    Risk that a tax authority will change tax legislation which will negatively influence the investment. Higher tax on investment income reduces real returns and can subsequently reduce the price of investments in the secondary market.
  8. Market risk:
    Risk that market conditions can negatively influence investment returns. For example, the prices of securities is dependent on general supply and demand which fluctuates independent from any specific security. Market risk is usually dependent on economic conditions such as inflation, consumer sentiment or the availability of credit.
    Although market risk influences most investments, some investments are influenced more than others. How much and investment is influenced through market risk is measured by price volatility, especially in relation to an index of similar investments. For example, some securities rise more when markets rise, or fall more when markets retreat. Sometimes an investment can be anti-cyclical to other similar financial instruments. As a result, these investments rise when the general market retreats, and vice versa.
  9. Event risk:
    Risk of an event which can have an impact on the potential return of an investment. Usually event risk is the risk that influences a single company and its securities, like the loss of a lawsuit or an accounting scandal. Sometimes event risk can influence a number of securities, like the political risk that a country will do something which will affect the prices of securities of companies residing there, like increased taxation, showing away of foreign investments, or in extreme cases, the nationalisation of companies without proper compensation.
  10. Liquidity risk:
    Risk that an investment cannot be sold quickly for a reasonable price. Property, for example, is a non-liquid investment because it takes quite a while to sell unless it is sold for less than its market value.

These are the most common investment risks which influences most investments. There are however other risks which influence investments. We aim to reduce these risks to an acceptable level through diversification, although not all risks are easily controllable.

Determining individual risk profiles

We take into account the following variables to determine our clients’ individual risk profiles:

  1. Investment term: 
    For example, 0-3 years, 3-5 years, 5-10 years and 10 years plus. The longer the term of the investment, the more exposure to shares can be afforded.
  2. Investment aim- or goal (with how much should capital growth outperform inflation?):
    For example, to outperform inflation by 2% a minimum period of 3 years is recommended, to outperform it with 4% a minimum period of 5 years is recommended and to outperform it by 6% a minimum period of 7 years is recommended.
  3. Guidelines with regards to risk and potential losses which can be experienced:
    For example, to outperform inflation with 2% the potential capital loss over 1 year can be 0%-2%, to outperform inflation with 4% the potential capital loss over 1 year can be as much as 7% and to outperform inflation by 6% the capital loss over 1 year can be as much as 15%.
  4. The maximum exposure to specific asset classes:
    If you want to combine a mixture of asset classes within your portfolio with which you feel comfortable with you can indicate this and we can recommend funds for that purpose.
  5. Any specific preferences which you may have with regards to investments:
    Domestic versus offshore, property versus cash versus bonds versus shares, et cetera.

Based on the results of your risk profile we start identifying funds which might be suitable for your portfolio. Please note that the investment periods and percentages above are very subjective and that the portfolio composition needs to go through three other processes before it is finalised, namely the PlexCrown ratings, the Moonstone Information Refinery, the Sanlam Glacier Risk Assessor and Regulation 28 of the Pension Funds Act of 1956.

PlexCrown Ratings

According to the PlexCrown model unit trusts are evaluated according to different criteria and a number of stars are awarded to each fund. This enables investors to know how a specific fund has performed over a specific period in comparison with other funds in its sub-category on a “risk-adjusted return” basis, as well as taking into account the fund manager’s abilities.

The PlexCrown ratings is independent and totally objective because they are based on quantative measures. Fund managers’ reputation, experience, investment processes and strategies, as well as risks (market or specific) are all added together to achieve the result of return per unit of risk.

The PlexCrown ratings are therefore a measure of constant performance because evaluations are performed over a series of periods which range from up to five years and are weighted on this basis. These evaluations are updated monthly and produces the latest information about how funds are performing.

Moonstone Information Refinery

The PlexCrown ratings does not evaluate money market funds because their mandates are very strict in terms of which instruments they may hold. The interest rates should not differ materially because it is primarily linked to the prime lending rate.

Moonstone Information Refinery publishes the interest rates of the top thirteen money market funds which is available for investment on a weekly basis, and we select our money market funds from this list.

Glacier Risk Assessor

After we have identified the top funds from the PlexCrown ratings we incorporate them into a risk model which is compiled by Sanlam Glacier’s investment analysts to determine a portfolio’s total relative risk basis. This Glacier RA is updated on a quarterly basis with the latest information.

A risk score of between 0 and 10 is awarded to each fund in a portfolio composition and illustrates the level of risk which each fund inherently represents. This model therefore illustrates how funds correlate with each other to determine a portfolio’s total risk score.

The table below indicates the level of risk for each risk score as calculated by the Risk Assessor:

Conservative

Cautious

Moderate

Moderate aggressive

Aggressive

0-2

2-4

4-6

6-8

8-10

When the risk score of each fund is calculated the following variables are taken into account for 1 year, 3 year and 5 year periods, as applicable:

  1. Downward volatility:
    Measured through downward variance, it calculates the variance of the fund’s return above the risk-free return in the market.
  2. Inconsistent returns:
    Measured through the annual standard deviation, it calculates the variance of a fund’s return around its average return.
  3. Asset risk of the fund:
    Measured through a classification from 1 to 10 calculated for each collective investment sector, it determines the underlying risk associated with investments in various sectors.

Regulation 28 of the Pension Funds Act of 1956

To date, Regulation 28 of the Pension Funds Act was only applicable to pension funds, provident funds, retirement annuity funds and preservation funds (‘retirement funds’) as a whole, resulting in some members being over-exposed to certain asset categories or having no exposure to other asset categories at all. In terms of the latest amendments, Regulation 28 compliance is now required on individual investment plan level.

The limit on exposure to equities is retained at 75%, while the limit on exposure to property is retained at 25%. The limit on exposure to foreign assets is currently 25%, but will be determined, and can be amended, by the South African Reserve Bank in future. The aggregate exposure limit of 90% with respect to equities and property is no longer applicable.

Please note that Regulation 28 is only applicable on retirement funds and not on discretionary unit trusts as well. You can still have unlimited exposure to shares, property and foreign investments in your unit trust portfolio.

Internal Rate of Return on Investments (‘IRR’)

An investment’s IRR represents the total return (both income and capital growth) which has been achieved over a certain time. We monitor the IRR on our clients’ investments on a regular basis.

To determine an investment’s real investment return over a period of time we compare its IRR with the official average Consumer Price Index (‘CPI’) rate according to Statistics South Africa (www.statssa.gov.za) for the corresponding period.

For example, an investment is placed on 1 January 2004. Since that date the IRR has been 9% per year and the average CPI rate for the corresponding period  was 6% per year. The investment has therefore underperformed inflation with 3% per year, and this represents the real return of the investment.

Conclusion

This document represents VRR’s investment strategy as a whole. There are however various other factors to consider with individual investments and we recommend that you contact us if you require a complete investment analysis.