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Performance in the spotlight – Section 12J Investments

Understanding the landscape, by having the right performance data, is critical for investors.
Image: Shutterstock

This year marks the 12th year that South African taxpayers are able to take advantage of the Section 12J tax incentive. Although the incentive has been around since 2009, promoters of Section 12J investments have for many years been guilty of luring investors through the attractiveness of the tax benefit and not nearly enough focus has been placed on the performance of the underlying investments.

This is evident through how these investments are being marketed. As an example, many promoters only market potential high targeted returns (which almost always includes the tax benefit), as opposed to publishing the actual returns investments are achieving (excluding the tax benefit).

This is particularly unusual in an investment landscape where investors make use of performance results to make an informed investment decision.

Having reviewed the performance of a number of Section 12J investments, it is  apparent as to why so many of these investment promoters do not make their performance data publicly available. Fortunately for their investors, the tax saving does cushion negative performance, however, the lower the investor’s tax bracket, the lower the buffer before risk capital is eroded.

Some Section 12J investments do make their returns publicly available. From the more conservative investments, one can estimate that a fair benchmark to measure the historic returns of these investments, is between 4% to 9% per annum (after all fees and taxes but excluding the tax benefit). By including the tax benefit, these investors are experiencing an additional annual return of up to 8%.

What has come out of my review, is that the underperformance of some of these investments is generally attributable to three factors, namely:

High performance fees: Particularly where the performance fee is not only charged on the performance of the investment but also on the tax refund amount – this type of fee is commonly referred to as a  ‘Net Investment Performance Fee’.

Cash drag: Section 12J investments which have failed to invest investors’ capital timeously, have been negatively affected by the low interest rates in a depressed economic environment. This issue may have been avoided if the promoters/managers of the investments invested capital under management within a reasonable time period.

Performance of the underlying investments: Covid-19 has without a doubt affected the performance of a number of Section 12J investments, thereby eroding investors’ returns.

While exposure to unpredictable market risks such as the outbreak of a pandemic is difficult to mitigate against, prospective investors can protect themselves against the remaining two factors, by simply asking for a breakdown of the fee structure and the percentage of capital under management invested.

Understandably, having the right performance data at an investor’s disposal is critical when making an informed investment decision. Investors should engage with the investment promoter to make absolutely certain that they understand how the investment has performed and what fees they are been charged. Alternatively, an investor would be well advised to engage an experienced financial advisor who has taken the time to perform a due diligence on a number of Section 12J investments.

Jonty Sacks, Partner – Jaltech Fund Managers   

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