Re­tire with in­vest­ments that put yield first

In­vest for in­come by seek­ing eq­uity and listed prop­erty in­vest­ments that pro­vide in­come in div­i­dends

Saturday Star - - P E R S O N A L F I N A N C E - MARTIN HESSE | [email protected]

FOR MOST of our work­ing lives, we in­vest to ac­cu­mu­late wealth, typ­i­cally in re­tire­ment funds and in dis­cre­tionary in­vest­ments, such as unit trusts, prop­erty or shares.

When we reach re­tire­ment, how­ever, the process goes into re­verse. Our sav­ings must pro­vide us with an in­come, and the in­vest­ments we use – typ­i­cally in a liv­ing an­nu­ity – should re­flect this. In the pre­re­tire­ment phase you in­vest pri­mar­ily for cap­i­tal growth, but in the postre­tire­ment phase you need to in­vest pri­mar­ily for in­come, al­though tak­ing growth into ac­count to en­sure that your cap­i­tal lasts.

Two fund man­age­ment com­pa­nies in South Africa, Bridge Fund Man­agers and Mar­riott, spe­cialise in in­vest­ing for in­come. They do this, in essence, by seek­ing eq­uity and listed prop­erty in­vest­ments that pro­vide a re­li­able in­come flow in the form of div­i­dends.

Marc Thomas, the head of mar­ket­ing and dis­tri­bu­tion at Bridge, says re­turn is made up of price and in­come. If you take a listed share, for ex­am­ple, the price is what the mar­ket will pay for it, while the in­come is the div­i­dend the com­pany pays an­nu­ally to share­hold­ers. (If you were in­vest­ing for growth, you would nor­mally elect to have div­i­dend dis­tri­bu­tions ploughed back into your in­vest­ment.)

The value of your cap­i­tal is de­ter­mined by the price, but this is of less im­por­tance for some­one draw­ing an in­come than the in­come por­tion of the re­turn, be­cause, al­though the cap­i­tal value may fluc­tu­ate as the mar­kets rise and fall, the in­come from div­i­dends is rel­a­tively steady, par­tic­u­larly from a re­li­able div­i­dend­pay­ing com­pany.

Say, for ex­am­ple, you buy a share at R100, with a div­i­dend yield of 5%. You will re­ceive R5 a year on that share, even though its price may be down at R80 one day and up at R120 the next. If the com­pany is a re­li­able div­i­dend payer, this will pro­vide you with a sta­ble in­come flow, which may keep pace with in­fla­tion if the com­pany ad­justs its div­i­dends up­wards, year on year, as many do.

Says Thomas: “If you can live off the in­come alone, as­sum­ing the yield keeps pace with in­fla­tion, you won’t touch the cap­i­tal, and you don’t even have to think about it. If you are not sell­ing shares (or units in a unit trust fund), you need not be con­cerned about mar­ket volatil­ity.”

In­vest­ing in this way not only pro­vides you with a steady in­come; it pro­vides the peace of mind you would not en­joy if you were con­cerned with re­turn on cap­i­tal. Plus, in the long term, the unit/share price should rise, giv­ing you cap­i­tal growth.

It also shields you from se­quenc­ing risk, Thomas says. This is the risk of the se­quence of re­turns be­ing not in your favour, which would hap­pen if, once you start draw­ing an in­come, a pe­riod of poor re­turns pre­cedes a pe­riod of good re­turns (see graph).

THE NA­TURE OF THE PORT­FO­LIO

How would an in­vest­ment fo­cus­ing on in­come be struc­tured?

Thomas says the port­fo­lio will pri­mar­ily in­vest in growth as­sets, be­cause, al­though you can re­ceive an in­come (in the form of in­ter­est) from a fixed-in­ter­est in­vest­ment, such as a money mar­ket or bond fund, it does not rise with in­fla­tion.

A tra­di­tional multi-as­set fund will not give you the de­sired in­come yield. “The av­er­age bal­anced fund gives only about 0.5% to 1.5% (af­ter fund fees) in yield. How­ever, your yield af­ter costs in a to­tal re­turn in­come ef­fi­cient port­fo­lio can be as high as 6%,” Thomas says.

Start­ing div­i­dend yields – the yield when you buy a share – are im­por­tant, he says. A low share price nor­mally gives you a rel­a­tively high start­ing yield, and vice versa.

Thomas says the ap­pro­pri­ate as­set classes are lo­cal and global eq­ui­ties, and lo­cal and global listed prop­erty. How­ever, the tilt should be to lo­cal as­sets be­cause:

◆ They are linked to lo­cal in­fla­tion;

◆ They pro­vide higher yields;

◆ Off­shore as­sets are sub­ject to ex­change-rate volatil­ity; and

◆ There is a with­hold­ing tax on off­shore div­i­dends. (The 20% with­hold­ing tax on lo­cal div­i­dends does not ap­ply to liv­ing an­nu­ities.)

“This doesn’t mean the port­fo­lio shouldn’t have an off­shore com­po­nent,” Thomas says, “but you shouldn’t draw from it – it would be too volatile.”

In­come-fo­cused funds aim for a yield of 5% or 6%, grow­ing with in­fla­tion. Bridge’s funds in­clude listed prop­erty, with some prop­erty in­vest­ment com­pa­nies fo­cus­ing on South Africa, oth­ers more off­shore. The eq­uity por­tion is equal-weighted, to limit ex­po­sure to any sin­gle com­pany. Com­pa­nies that don’t pay div­i­dends or that pay un­re­li­able or low div­i­dends are fil­tered out in the se­lec­tion process.

Un­less you were very wealthy, even in an in­come port­fo­lio you would prob­a­bly have to dip into your cap­i­tal to a cer­tain ex­tent. “Not dip­ping into cap­i­tal is an ideal sit­u­a­tion,” says Thomas. “The in­come cov­er­age ra­tio is the pro­por­tion of your draw­down in­come that is cov­ered by as­set in­come, and it should ideally be no less than 70 to 75%.”

Be­cause many pen­sion­ers need a lit­tle more than yield, which presents se­quence risk, Thomas says Bridge has de­signed a cash-flow strat­egy for its liv­ing an­nu­ity whereby a max­i­mum of two years’ in­come goes into a cash port­fo­lio. The bulk of the in­vest­ment is in a yield-growth port­fo­lio, and the in­come gen­er­ated flows into the cash port­fo­lio.

Bridge has adopted the same prin­ci­ples in a pre-re­tire­ment in­vest­ment for clients in the last four or five years be­fore they re­tire, which off­sets risk in the same way.

Thomas says: “The ad­van­tage is that you get max­i­mum ex­po­sure to growth as­sets and, with a few years to go, once you have a good idea of what your re­tire­ment in­come will be you can start pre­par­ing your port­fo­lio to gen­er­ate the in­come you need. You will also have two years’ in­come al­ready avail­able on re­tire­ment date.

“It of­fers pro­tec­tion against a mar­ket down­turn af­fect­ing your abil­ity to re­tire as planned, but if the pro­tec­tion is not needed be­cause of good mar­ket re­turns, one to two years’ in­come is not too much of a drag on the port­fo­lio and still pro­vides in­come pro­tec­tion against volatile mar­kets once you are in re­tire­ment,” Thomas says.

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