The importance of active management for living annuity investors

The combined impact of volatility and real returns on income rates.

14 Feb 2019

5 minutes

The combined impact of volatility and real returns on income rates.

This article is the fourth in our series1 on how to manage a living annuity to provide an inflation-proof income over a period of 30 years.

We quantify the extent to which an active fund manager can add value to a living annuity portfolio, specifically by managing the portfolio in a way that improves the probability of that annuity delivering a 30-year inflation-proof income. This article builds on the key learnings from the first three articles in our series, exploring the relationship between a reduction in portfolio volatility and an increase in the sustainable income from a living annuity.

From our research, using index return data going back to 1900,2 we make a key conclusion: While real returns matter to living annuity investors (as they would to any investor), most living annuity investors underestimate the extent to which lower volatility portfolios make a meaningful difference to the long-term health of their living annuity.

Reviewing the impact of real return and volatility on sustainable incomes

In our first article1 we established the following relationships between a living annuity’s maximum sustainable income rate and the real return and volatility of the underlying investment portfolio:

If the long-term real return in the portfolio changes by 1% p.a., the sustainable annual income rate for the living annuity changes by 0.9% p.a.

impact of real return and volatility on sustainable incomes infographic

If the long-term volatility3 of the portfolio increases by 1%, the sustainable annual income rate for the living annuity reduces by 0.3% p.a.

These results concluded that volatility was an important driver of living annuity success, because high volatility magnifies the impact of sequence of return risk on a pensioner (i.e. the impact of retiring in a bear market as opposed to a bull market).

We then briefly highlighted how investments that beat their benchmarks on both performance as well as volatility can contribute significantly to the success of a living annuity strategy, using the performance histories of some ASISA category1 averages and the Opportunity Fund. Let’s take a closer look at the power of this return-volatility combination.

Table 1 reflects results from our living annuity modelling engine.2 The table sets out the maximum sustainable initial income rate for a living annuity (subject to a 10% probability of failure and an investment term of 30 years) for portfolios comprising different combinations of real return and volatility.

Table 1: Maximum sustainable initial annuity income rates for different combinations of portfolio real return and volatility

Volatility of real
returns p.a.
Portfolio return
CPI + 4% CPI + 5% CPI + 6% CPI + 7% CPI + 8% CPI + 9%
8% 3.6% 4.5% 5.4% 6.3% 7.2% 8.1%
9% 3.3% 4.2% 5.1% 6.0% 6.9% 7.8%
10% 3.1% 4.0% 4.9% 5.8% 6.8% 7.5%
11% 2.8% 3.7% 4.6% 5.6% 6.5% 7.2%
12% 2.5% 3.4% 4.4% 5.3% 6.2% 6.9%
13% 2.2% 3.1% 4.1% 5.0% 5.9% 6.6%
14% 1.9% 2.8% 3.8% 4.7% 5.6% 6.3%

Source: Ninety One SA (Pty) Ltd, in-house model.

The table highlights how a living annuity investor can benefit from a combination of:

  • A high real return
  • A low volatility

Applying the return-volatility table to actual examples

In our first article we investigated the impact of volatility using the Opportunity Fund, a number of other funds and industry sector averages. Analysing the performance and volatility data of these investments over the 20 years from 1 January 1999 to 31 December 20184 we obtain the following results:

  • The Median Multi-Asset High Equity unit trust fund delivered a return of CPI + 7.2% p.a., at an annualised volatility of 10.9%, over this period.
  • The Opportunity Fund delivered a return of CPI + 8.4% p.a. with an annualised volatility of 9% over this period.
  • One of the poorer performing funds in the Multi-Asset High Equity sector (Fund Z) delivered a return of CPI + 6.7% p.a. and an annualised volatility of 11% over this period.

Plugging the performance and volatility numbers of these three investment options into Table 1, gives us maximum starting incomes which these different investment portfolios would have been able to support over a thirty-year period, as shown in Table 2.

Table 2: Combined impact of volatility and real return on income rates

Portfolio Real return Annualised
Max sustainable
starting income
Fund Z 6.7% 11% 5.1%
MA High Equity Median 7.2% 10.9% 5.6%
Opportunity Fund 8.4% 9% 7.3%

Source: Morningstar and Ninety One SA (Pty) Ltd, as at

Table 2 highlights how incredibly sensitive a living annuity’s sustainable income rates are to the quality of the investment portfolio. If a pensioner invested for 20 years with an underperforming manager, their sustainable income would be 10% lower than if they had invested with an average manager. A poor performing manager poses a bigger risk for living annuity investors than other investors, because managers who underperform over long periods of time often also exhibit higher volatility signatures. This represents a double blow to living annuity investors, as Table 2 shows.


Living annuities present a unique challenge to financial advisors. Due to the combined impact of volatility and real return on a living annuity’s prospects of success, financial advisors need to pay close attention to the likely ‘volatility alpha’ of their active managers, in addition to the expected ‘return alpha’.

Financial advisors should seek out active managers who can deliver on both ‘return alpha’ as well as ‘volatility alpha’. Identifying such fund managers arguably represents the biggest potential improvement to a living annuity’s maximum sustainable income rate.

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2 See the Appendix for a brief description of the model and its assumptions.
3 Defined as the standard deviation of the annual real returns
4 Source: Morningstar.
5 Monthly returns are used as input into our in-house living annuity modelling tool to calculate the maximum sustainable starting income. Performance figures are based on lump sum investments, NAV based, inclusive of all management fees, but excluding any initial charges, gross income reinvested. Investment performance is for illustrative purposes only to show the volatility and real return impact. The returns for the Opportunity Fund are based on the combination of class A and R performance which were the most expensive classes over the period. R class inception date: 02.05.97 and A class inception date: 02.04.00. CPI inflation lags by one month. The TER of the Opportunity Fund (A) class is 1.50%, and highest and lowest 12-month rolling returns since inception is 43.8% (31.07.05) and -15.7% (28.02.09), respectively.

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Authored by

Jaco van Tonder

Advisor Services Director

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This communication was originally published by Investec Asset Management (Pty) Ltd, the predecessor of Ninety One SA (Pty) Ltd. The information is accurate as at the original date of publication, but any views expressed may no longer be current. The communication has been republished in our new branding but has not otherwise been updated.

This Viewpoint details Ninety One SA (Pty) Ltd research findings on the importance of volatility for income-generating portfolios, and the role of active management. The information presented here is not intended to be relied upon as investment advice. Various assumptions were made. There is no guarantee that views and opinions expressed will be correct. The findings expressed here may not reflect the views of Ninety One SA (Pty) Ltd as a whole, and different views may be expressed based on different investment objectives. Ninety One SA (Pty) Ltd has prepared this communication based on internally developed data, public and third party sources. Although we believe the information obtained from public and third party sources to be reliable, we have not independently verified it, and we cannot guarantee its accuracy or completeness. Ninety One SA (Pty) Ltd does not provide any financial advice. Prospective investors should consult their financial advisors before making related investment decisions. Collective investment scheme funds are generally medium- to long-term investments and the manager, Investec Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing and scrip lending. The fund may borrow up to 10% of fund net asset value to bridge insufficient liquidity. A schedule of charges, fees and advisor fees is available on request from the Manager which is registered under the Collective Investment Schemes Control Act. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant Total Expense Ratio (TER). Ninety One SA (Pty) Ltd is a member of the Association for Savings and Investment SA (ASISA). This is the copyright of Ninety One SA (Pty) Ltd and its contents may not be re-used without Ninety One SA (Pty) Ltd’s prior permission. Ninety One Investment Platform (Pty) Ltd and Ninety One SA (Pty) Ltd are authorised financial services providers. Issued, February 2019.