The value of rand-denominated offshore feeder funds
Sep 17, 2019
5 minutes
In a series of articles, Jaco van Tonder, Advisor Services Director at Ninety One, discusses the results of an in-depth research study aimed at answering the question; “How to manage a living annuity to provide an inflation-proof income over a period of 30 years?”
From our research, using index return data going back to 1900,1 we make several key conclusions (each discussed in detail in the relevant article):
- The annual income review and applying a flexible drawdown strategy is crucialto the longevity of the annuity.
- Living annuities need a strong growth engine, which includes solid exposure todomestic and offshore equities.
- Lower volatility improves survival probabilities for an income-producing portfolio because it helps the portfolio manage sequence-of-return risk more effectively.
- Active management can impact investor outcomes significantly, in particular their ability to deliver better risk-return characteristics.
In this article we will expand on how a rand-denominated offshore feeder fund, and specifically the Ninety One Global Franchise Feeder Fund can help living annuity investors maximise the benefits available from the last three conclusions above.
All retirement income portfolios require local and offshore equity exposure
Our research on optimised portfolios firstly indicates that to minimise failure risk (the risk that the living annuity runs out of money within 30 years), living annuities with a starting income of 5% or more should have equity exposure greater than 70%. A second key observation is the extent to which our asset allocation optimiser model includes offshore equity for all annuity portfolios, irrespective of the level of their starting incomes. Figure 1 highlights the split between South African equities and offshore equities within the optimised annuity.
Figure 1: Domestic and offshore equity exposure
Source: Ninety One.
The model proposes an offshore equity exposure in the region of 20 – 40% of the total portfolio across all starting incomes. For many, this conclusion may appear odd – why should an investment aimed at delivering income in South African rand be required to hold such a large exposure to offshore equities? Does the additional currency volatility not negate the benefits of the offshore equity returns? And why does the model allocate mostly to offshore equities for lower initial incomes, but increase the allocation to domestic equities as income levels go over 6%?
The answers to these questions lie in the unique diversification benefits of offshore equites when combined with a South African portfolio of bonds and equities:
- Domestic equities delivered a higher historical real return than offshore equities.
- However, offshore equities have the advantage of a negative correlation with South African bonds, as evidenced in the following table:
20-year correlation of asset class returns (all in South African rand)
| SA Equities | SA Cash | SA Bonds | Global Equities | Global Bonds | |
| SA Equities | 1.00 | ||||
| SA Cash | -0.12 | 1.00 | |||
| SA Bonds | 0.09 | 0.12 | 1.00 | ||
| Global Equities | 0.47 | -0.24 | -0.35 | 1.00 | |
| Global Bonds | -0.07 | -0.01 | -0.38 | 0.54 | 1.00 |
Source: Morningstar, as at 31.08.20.
Therefore, our portfolio optimiser model adds offshore equities first at lower income levels, thereby increasing both the real return potential and the overall risk profile of the portfolio. However, as the income draw increases, the stronger real return from domestic equities becomes more important than the lower volatility of the offshore equities.
As an aside, it is this interplay between real return and portfolio volatility that Clyde Rossouw and the Quality capability at Ninety One are exploiting in the current portfolio construction of the Ninety One Opportunity and Ninety One Cautious Managed Funds. Offshore equities (high quality global franchises on attractive valuations) remain the team’s preferred asset class and primary driver of real returns, followed by South African nominal bonds and then select South African equities.
This positioning is contrary to traditional multi-asset portfolio construction, where South African equities were considered the primary driver of real returns and offshore bonds the “uncorrelated defensive” asset.
Increase offshore (and equity) exposure using a rand-denominated global equity feeder fund
A cursory analysis of the average Multi-Asset High Equity fund’s exposure to equities and offshore assets suggests that living annuities that make use of a selection of these funds will be underexposed to both. The ASISA end-June 2020 quarterly statistics2 indicate an average equity exposure in the region of 55-60% for the Multi-Asset High Equity sector, and an average offshore exposure of approximately 25%. This is not dissimilar to the picture both three and five years ago.
A simple way then to increase offshore exposure in a living annuity portfolio is to include a rand-denominated feeder fund as an underlying holding. And what better way than to do so via an actively managed fund such as the Ninety One Global Franchise Feeder Fund that demonstrates lower-than-market volatility?
The Ninety One Global Franchise Feeder Fund
As the name indicates, the Ninety One Global Franchise Feeder Fund invests in the Global Franchise Fund, which:
- Seeks to invest in world-leading companies with strong competitive advantages, superior margins and a focus on capital reinvestment.
- Is a high-conviction portfolio of 25 – 40 stocks of primarily investment-grade companies, with high customer loyalty, strong brands and no debt.
- Can play an important role in a living annuity portfolio, as this equity-only fund carefully manages exposure to maximise downside protection and participate meaningfully in rising markets.
We believe that the fund has the right attributes to withstand most economic conditions and has delivered an excellent track record with low volatility since inception, as evidenced in Figure 2.
Figure 2: Average rolling 12-month performance of the Ninety One Global Franchise Fund (the target fund) since launch April 2007 (USD)
Past performance should not be taken as a guide to the future, losses may be made. Data is not audited. Source: Morningstar, as at 31.08.20, Performance is NAV based, (inclusive of all annual management fees but excluding any initial charges), gross income reinvested, in USD, based on the A Acc share class. Performance is based on the OEIC Ninety One Global Select Equity Fund (launched 10.04.07) which then merged into the Luxembourg-domiciled Global Franchise Fund on 04.07.09. Rolling 12 month periods since month end following inception: 30.04.07. Highest and lowest 12 month rolling returns achieved over 10 years: Highest 54.4% (28.02.10) and Lowest: -38.7% (28.02.09). Annualised performance is the average return per year over the period. Individual investor’s performance may vary depending on actual investment dates.
Conclusion
We believe that it makes sense for many investors and advisors to consider including an allocation to a rand-denominated feeder fund as an underlying building block to a living annuity portfolio. Funds such as the Ninety One Global Franchise Feeder Fund that can deliver both strong long-term real returns together with lower volatility can have a big positive impact on a living annuity portfolio.
1 See the brief description of the model and its assumptions.
2 Source: ASISA https://www.asisa.org.za/statistics/collective-investment-schemes/local-fund-statistics/