WEALTH OF INSIGHT THE BENEFITS OF SOLUTION FUNDS MONTHLY FINANCIAL PLANNER NEWSLETTER OLD MUTUAL WEALTH INTELLIGENCE. Issue 4

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1 THE BENEFITS OF SOLUTION FUNDS MONTHLY FINANCIAL PLANNER NEWSLETTER Issue 4 November/December 2013

2 WHY SOLUTION FUNDS ARE THE WAY TO GO Let s define a solution fund as follows: a fund that is mandated to deliver in accordance with a client s total investment need (such as inflation plus 3%), rather than in terms of an asset class benchmark (such as the ALBI, and SWIX). Solution funds typically have a risk objective, such as avoiding negative returns over certain rolling periods. Typically, solution funds are multi-asset class funds where the fund manager is responsible for security selection, asset allocation and geographical allocation. Often, these are multi-managed funds, where clients benefit from exposure to different fund managers, with the manager selection and portfolio blending being done by a professional multi-manager. Old Mutual Wealth s Strategy Funds are all solution funds, as are most of the funds in our Target Range. A single solution fund should by definition be enough to take care of a client s financial objectives. Different solution funds can be combined in a portfolio, provided that the combination makes sense. Multi-managed solution funds have the benefit that considerable research goes into the manager selection and portfolio construction, while the multi-manager s bulk-buying power means it is often cheaper than it would be if the planner combined individual funds into a DIY portfolio. There are several benefits to using solution funds for both clients and financial planners. Benefits For clients Diversification Solution funds invest across different asset classes (bonds, equities, property and cash) and jurisdictions (local and offshore). They also diversify within asset classes, so that the portion of the fund is spread over a range of shares, and the bonds portion could include government bonds, inflation-linked bonds and corporate bonds. The old principle of not putting all your eggs into one basket applies. While diversification is important, what is also important is asset allocation, the proportion of the fund allocated to each asset class. When market conditions warrant it, the fund manager can change the asset allocation quickly, based on his/her expert opinion. For a financial planner to change the asset allocation, the client s signature is required for the switch. Tax A big benefit of investing with a unit trust fund (or a collective investment scheme, to go by its legal name), is that capital gains tax is deferred until the client sells units. This benefit is largely lost if one has to rebalance a portfolio that consists of several funds (and rebalancing is something that has to occur to ensure the portfolio can achieve its original objective). In a solution fund, the fund manager can change the allocation between asset classes based on market views and the fund mandate, without having to worry about the immediate tax impact on clients. Mapping to need At Old Mutual Wealth, we believe that most clients investment goals can best be expressed in their attitude towards inflation. In others words, the extent to which the client needs to beat inflation. To preserve existing wealth, one needs to match or outperform inflation; otherwise you are only preserving a number on a screen and not the purchasing power that number represents. To grow wealth, your investment needs to beat inflation. Solution funds have the benefit of linking their mandate or benchmark to inflation. In other words, they have a specific inflation-plus target they aim to beat. Clients thus understand what the fund aims to do, and how this maps to their individual needs. At Old Mutual Wealth, client goals and needs are expressed as Investment Strategies, and for each Investment Strategy we have Strategy Funds. There is a one-to-one mapping between Strategy and Strategy Fund, making fund selection an easy and sensible process. Benefits for planners Meeting regulations According to Investors Chronicle, a UK-based magazine, multi-asset solution funds are increasing in popularity and importance as a means of meeting the demands of growing regulations, such as the Financial Services Authority s Treating Customers Fairly (TCF) initiative and the Retail Distribution Review (RDR). TCF will be implemented locally next year, and it requires that clients understand what they are buying, and why. The benefit of the solution fund, as explained above, is that the aim of the fund is linked to the client s goal. Expectations are thus managed more easily than by having a number of single asset class funds combined in a portfolio. and Old Mutual Life Assurance Company (South Africa) Ltd, Licensed Financial Services Providers 2

3 Using solution funds also take care of compliance risks to a large extent since there is a clear mapping of the fund s mandate to the client s goal. Where applicable, Regulation 28 compliance is also taken care of by the fund manager. Simplification For some planners, it might require a shift in mind-set. Constructing portfolios has given them a sense of control, which is understandable. However, it is questionable how real this control was, since many planners end up with a large client base and an even larger range of funds that clients invest in. This is especially true when clients and their portfolios are inherited from other planners. Using a range of solution funds can considerably simplify the planner s life, while still meeting clients needs. Expertise The second argument is that selecting funds is where the planner adds value, or at least can demonstrate value. However, these planners are clearly selling themselves short. Selecting funds is only the last step of a financial planning process that requires great skill, insight and technical knowledge. The challenge is to get clients to realise the importance of this process. They are paying for setting up a financial plan, and for reviewing this plan on an ongoing basis. Moreover, the planner who takes credit for selecting good funds when the portfolio performs well also needs to take responsibility if the selected portfolio does not perform to expectations. Saving you time, saving clients money Solution funds are actively managed based on the fund manager s view of the markets and asset class return. By delegating asset allocation and security selection decisions to professional fund managers, planners have more time to spend with clients. Apart from the benefits listed above that apply to solution funds in general, our Strategy Funds in particular are very aggressively priced. In other words, clients do not have to pay extra for these benefits, instead they can save money. For you as a financial planner, managing your practice becomes much simpler in terms of reporting, fund selection, ongoing monitoring and reporting. It also becomes easier for succession planning or selling your practice. and Old Mutual Life Assurance Company (South Africa) Ltd, Licensed Financial Services Providers 3

4 Increasing popularity of multi-asset funds Research shows that investing as early as you can and sticking to your financial plan provides the best outcome over the long term. Investing in a fund which is diversified across asset classes should be able to weather the storms of volatility in financial markets. Even in South Africa we have seen an increase in popularity of the multi-asset category of unit trusts over the past two years. The latest Association for Savings and Investment South Africa (ASISA) Collective Investment Scheme statistics shows that nearly 42% of the unit trusts are invested in this space. For the twelve months ending September 2013, a whopping R117 billion flowed into this category. As a result we have seen a drop in funds invested in less risky money market unit trusts as investors have started to realise that they need an inflation-targeted return on their investments. 100% 0% TOTAL ASSETS PER ASSET CLASS 5.4% 5.5% 5.4% 5.4% 5.6% 5.7% 6.2% 6.5% 36.2% 38.2% 39.8% 39.9% 40.6% 40.6% 41.3% 41.6% 23.7% 25.2% 24.8% 24.1% 24.3% 24.3% 22.9% 23.4% 25.5% 23.5% 22.2% 21.5% 20.4% 19.5% 19.8% 18.9% 9.1% 7.6% 7.9% 9.0% 9.1% 9.9% 9.8% 9.6% Q Q Q Q Q Q Q Q Interest Bearing Money Market Equity (incl. Real Estate) Multi Asset Global & Worldwide In January 2013, ASISA revised the industry fund classifications for the South African regulated collective investments portfolios. The multi-asset category is now split up and defined as follows, with the industry assets and flows* in each category listed below: MULTI-ASSET FLEXIBLE These funds have a flexible asset allocation EXPECTED RETURN MULTI-ASSET INCOME These funds aim to maximise income. Max Equity: 10% Max Property: 25% Industry Assets: R103bn 12-month flows: R24bn MULTI-ASSET LOW EQUITY These funds have increased probability of short-term volatility and aim to maximise longterm capital growth. Max Equity: 40% Max Property: 25% Industry Assets: R149bn 12-month flows: R44bn MULTI-ASSET MEDIUM EQUITY These funds have average volatility and medium- to long-term capital growth. Max Equity: 60% Max Property: 25% Industry Assets: R33bn 12-month flows: R3bn MULTI-ASSET HIGH EQUITY These funds have increased probability of short-term volatility and aim to maximise longterm capital growth. Max Equity: 75% Max Property: 25% Industry Assets: R255bn 12-month flows: R41bn dictated by the fund s mandate. They may be aggressively managed with assets being shifted between asset classes to reflect changing economic and market conditions according to the fund manager s discretion to maximise long-term total returns Industry Assets: R45bn 12-month flows: R5bn EXPECTED VOLATILITY and Old Mutual Life Assurance Company (South Africa) Ltd, Licensed Financial Services Providers 4

5 At Old Mutual Wealth, most of our Strategy Funds fall into the Multi-Asset Categories: StrategY Suited to clients who require: OLD MUTUAL INVESTMENT GROUP OLD MUTUAL MULTI MANAGERS CATEGORY Enhanced Income A high level of current income and/or capital stability. (For risk-averse investors). Old Mutual Enhanced Income Enhanced Income Multi-Asset Income Inflation plus 2-3% A growing income stream over time, and/or inflation protection with moderate volatility only. Old Mutual Real Income Cautious Multi-Asset Low Equity Inflation plus 3-4% Medium-term inflation-beating returns without excessive risk. Old Mutual Stable Growth Defensive Multi-Asset Low Equity Multi-Asset Medium Equity Inflation plus 4-5% Significant inflation-beating returns, accepting the associated volatility. Old Mutual Balanced Balanced Multi-Asset High Equity Inflation plus 5-7% High real capital growth rates from mostly local assets, or Regulation 28 compliance for retirement investments. Old Mutual Flexible Old Mutual Edge 28 SIS Inflation Plus 5-7 Multi-Asset Flexible Maximum Return The highest possible return available from local and global assets over the long term. Old Mutual Maximum Return SIS Inflation Plus 7-9 Multi-Asset Flexible Cash A short-term parking bay with no capital volatility Old Mutual Money Market Money Market Interest Bearing - Money Market * Industry flows and AUM as at 30 September 2013 and Old Mutual Life Assurance Company (South Africa) Ltd, Licensed Financial Services Providers 5

6 Fitting an Investment Strategy into your client s plan for life Essentially, financial planning is about illustrating the gap between where a client is now and where they would like to be and then defining a strategy or plan to bridge this gap. Old Mutual Wealth s planning process and range of investment strategies provide a mechanism for defining and bridging this gap, starting with a clear understanding of the client and their requirements. Where are they now, and what do they want to achieve? Traditionally financial planning focused heavily on defining an investment objective for the client s money and investing accordingly like investing to try and beat the return that an investment in the All Share Index (ALSI) might provide, and benchmarking the returns on a regular basis. The Old Mutual Wealth planning approach and investment strategy solutions shift the focus to first understanding the client and their goals. Once the goals have been clearly defined we can start modelling the investment return they would need to achieve, based on their current financial circumstances and relative to their unique individual requirements. A solution designed on this basis gives the client focus to use their money as a means to do the things they really want to do, rather than investment that needs to be grown with no specific purpose. The investment return needed determines how that money should be invested which in turn determines the amount of investment risk. Old Mutual Wealth s Strategy Funds, targeting inflation-plus returns, are managed by the investment team to target the exact return the client requires as part of their plan or strategy. This takes out guesswork for both planners and clients. Importantly, the planning approach is not a linear process as each person s risk comfort levels are different. There are also many facets to risks that one needs to understand when selecting an appropriate investment strategy: The investment risk the client is comfortable taking; The association between investment risk and return; The understanding that risk decreases over time; The risk of not achieving one s goals; and The risk of not beating inflation. All of these risks need to be explored before an optimal balance can be reached. Each individual is unique! Our values, experiences, realities and preferences shape our decision making. It is imperative for a client s overall financial plan and specific selection of investment strategy to be aligned to the individual and their goals. Clients have four broad options or variables which must also be considered when creating their plan and selecting the investment strategy to bridge the gap. They can save more, spend less, work for longer or take on more risk by targeting a higher return. The most appropriate strategy or plan is found in the optimal combination of these variables. Some clients prefer to save more rather than take on more risk, whilst other clients prefer to take on more risk if it means they can retire earlier. Exploring all of these options and tailoring the strategy to the client will result in an optimum balance. Once the optimum balance has been found the next step is targeting the return required to achieve this lifestyle. The Old Mutual Wealth planning approach and its aligned Investment Strategies are premised on finding the optimal balance between: The return we require to achieve the life we want to live; and The level of risk we are comfortable taking; and then actively targeting this return. A great financial plan reflects a personalised strategy to bridge the gap between the client s desired lifestyle and current reality. Return or performance is only as good as the lifestyle it enables. and Old Mutual Life Assurance Company (South Africa) Ltd, Licensed Financial Services Providers 6

7 Stick with a plan, stick with a fund Sometimes the best advice a financial planner can give to a client is to stick to a plan. In today s age where information is everywhere, it can be quite daunting for clients to decide how to invest their money. Having conversations with friends who talk of the latest best performing assets or funds, and which to invest in may bring about a temptation to switch funds or follow the herd. This approach can be quite risky! What about performance? Is it important? In short, the answer is yes. However, simply chasing performance is not necessarily going to get to the desired outcome. What is important is ensuring that clients are following a plan and are invested in an inflation-targeted strategy that will enable them to reach the financial goals which are important to them. Each individual is unique so their goals will ultimately dictate the risk they will need to take to reach these aspirations. Is it really important that they have the highest return possible at the end of the day? No. What is important is that their selected funds or strategies meet their financial goals in the long term. In this way, everyone is a winner - even if they don t come first! At Wealth Intelligence, we did an exercise to examine the outcome if a client invested in two of our Strategy Funds ten years ago and stuck with them. We then made an assumption that someone chasing performance would, at the start of the investment term, choose the highest-performing unit trust in that category over the previous three years. One year later the investor would relook at this choice and again switch to the fund with the best performance over the previous three years. And this was repeated each year over the ten-year period. Interestingly, he did not achieve the highest performance he desired, and it goes to prove that past performance is no indication of future performance. To add to the analysis we added in what would happen if he invested in the average fund instead the average fund actually outperforms choosing the best performing fund! The annualised return for each decision over the ten years is as follows: Old Mutual Balanced Fund 16.47% SYm metry Balanced FoF 16.31% Best fund - 3 years 12.97% Average Fund 13.86% Worst fund - 3 years 11.93% In it for the long term Working towards your desired financial outcome is a long-term commitment. The best time to start investing is now - yesterday preferably! Clients need to remain committed in times of volatility and not try to time the market. The key message for clients is to stick with a plan, and stay in a strategy or fund for the long haul. In that way, it will be easier for them to realise their financial goals and meet their needs and lifestyle dreams Old Mutual Balanced Fund SYm metry Balanced FoF Average Fund Worst Fund - 3 Years Best Fund - 3 Years Sep 03 Mar 04 Sep 04 Mar 05 Sep 05 Mar 06 Sep 06 Mar 07 Sep 07 Mar 08 Sep 08 Mar 09 Sep 09 Mar 10 Sep 10 Mar 11 Sep 11 Mar 12 Sep 12 Mar 13 Sep 13 and Old Mutual Life Assurance Company (South Africa) Ltd, Licensed Financial Services Providers 7

8 Expert input FOR YOUR CLIENTS A pilot flying an airplane full of people without a licence is probably not a smart move. A similar case can be made for clients trying to select assets and shares for their own portfolios without access to the necessary research and data, experience and skills needed in the field of portfolio management, or the guidance of a qualified financial planner. This is why, at Old Mutual Wealth, we are great believers in asset allocation funds that offer clients access to a professionally and actively-managed portfolio that is diversified across regions, sectors and economies. This means that the portfolio manager is constantly monitoring global events and ensuring the portfolio is best positioned to avoid risks and will take advantage of market opportunities. Arthur Karas, a senior portfolio manager at Old Mutual Investment Group s MacroSolutions boutique gives us some insight into the demands of the job from an equity perspective. While most people generally spend their work days carrying out planned tasks with a degree of certainty in the outcome, managing an investment portfolio is quite a different undertaking. For one thing the investment task is never truly completed, and, second, success in the past is no predictor of future performance. And, while the desired outcome is outlined in the investment mandate, the objective can be successfully met via a number of different paths. It goes without saying that enormous resources are directed at trying to deliver on the investment mandate, but there is a limited degree of certainty in the outcome, or indeed the timing thereof. For example, an investment might appear to be a poor one for a number of months and then outperform for years, erasing all signs of earlier losses. Likewise, a company revered by the market for years can become unpopular in a matter of weeks. At the level of selecting individual investment holdings, the task might initially seem simple in that you research a share and you buy it or you don t buy it. But in contrast with many other jobs, there is not a single foolproof method for success. Even having correctly identified an investment as a buy or a sell in the past, provides little comfort as the portfolio manager s good track record with that share might inspire overconfidence. Another feature of investment management is how overall portfolio results are impacted by both investments held and those not held. Avoiding the bad investments can be as important to a period s performance as owning the winners. So, while there is no single foolproof method for investment success, the most powerful tools in a portfolio manager s toolbox are philosophy and process. Consider the following: Due to factors such as rising wages, low interest rates, social grants and a strong rand, over the past five years, clothing and food retailers have been amongst the JSE s best performers. Companies like Mr Price, Shoprite and Woolworths grew their earnings rapidly and, consequently, investors rewarded retailers with high valuations. However, at MacroSolutions, seen through our philosophy of theme and price (visit to see how we do it), we became increasingly uncomfortable with the high valuations in the retail sector, as the consumer boom continued. Over time the positive themes supporting the retail boom became increasingly mature and we cannot see the scope or scale widening significantly. The next move for interest rates is likely to be up, the rand has weakened meaningfully and household debt at the lower end of the market has risen markedly. We don t currently foresee a disaster for the consumer, but the tailwinds for the sector have definitely dropped off. To us, the MacroSolutions philosophy highlighted the sector as expensive with fading positive themes. As a result, we currently have quite limited exposure to listed SA food and clothing retailers in our portfolios. We also have no exposure to the unsecured lenders that helped drive the boom or to the furniture retailers that are very focused on the lower end of the consumer market. In contrast, we have remained positive on Richemont and Naspers, companies with exposure to consumers outside SA, with a focus on luxury goods and the internet consumer in China, respectively. Our decision to reduce our holdings in SA retail was early and a negative contributor to performance in 2012, but our portfolios have been rewarded in 2013, with retail being among the worstperforming sectors. By comparison, Richemont and Naspers are both up in the region of 50% for the year-to-date, benefiting from more reasonable valuations and strong positive themes. Using these examples helps to illustrate how, at MacroSolutions, philosophy and process are our key navigation tools. DISCLAIMER This document is for information purposes only and does not constitute financial advice in any way or form. It is important to consult a financial planner to receive financial advice before acting on any information contained herein. Old Mutual Wealth and its directors, officers and employees shall not be responsible and disclaims all liability for any loss, damage (whether direct, indirect, special or consequential) and/or expense of any nature whatsoever, which may be suffered as a result of or which may be attributable, directly or indirectly, to the use of, or reliance upon any information contained in this document. and Old Mutual Life Assurance Company (South Africa) Ltd, Licensed Financial Services Providers 8