Can one use tracker funds as part of a living annuity portfolio? And is there anything comparable in living portfolio unit trusts matching Absa’s five-year 13% fixed deposit return?
You can include tracker funds in your living annuity. There are many different options available – it will depend on the investment platform you use.
It is important to know which index you want to track as you also have the ability to have high offshore allocation. Living annuities are not subject to Regulation 28 of the Pension Funds Act, so you can have up to 100% offshore allocation, compared to 30% in a retirement, pension or provident fund.
Historically, the Satrix 40, which tracks the JSE Top 40 Index, was the best known [tracker fund], but nowadays there are many options. Providers such as Sygnia, CoreShares and Stanlib have launched tracker funds that replicate indices like the S&P 500, FTSE or the MSCI World Index, to mention a few. You need to decide if you want to allocate equity exposure via a global index, or a specific area like the US, Japan, Europe or South Africa.
Another strategy is to blend index trackers (which brings down costs) with active funds that have outperformed their benchmark and have a low correlation to the specific index. If you are happy to get returns that the index offers and are willing to sit out bumpy rides, then a 100% allocation to passive funds is the way to go.
A third option is using dynamic passive exchange-traded funds (ETFs). These funds make rule-based decisions to replicate certain indices and can change the indices if the managers believe there is good enough reason to do so. The costs of these dynamic passives are lower than active funds, but higher than normal passive ETFs.
I would choose an income fund, if you want an alternative to the five-year deposit in the living annuity option.
You cannot really compare it, as the nature of the investments is different. Absa will use the deposits it gets from investors and lend it out to debtors, charging a higher rate than 13%. Another important point to mention is that the 13% is with the assumption that you reinvest your interest every year; the annual rate is closer to 10%. The enhanced income funds – available within most living annuity options – invest in bonds and other cash instruments. Examples include the Coronation Strategic Income Fund, Investec Diversified Income Fund, Mi-Plan Enhanced Income Fund and Counterpoint SCI Enhanced Income Fund. These funds have delivered in excess of 8% and 9% in 2018. This return, unlike the Absa five-year deposit, is not guaranteed but is typically very stable.
Another important point to consider is the tax implications. The interest on the Absa deposit will be taxable, but the yield from income funds within a living annuity is tax-free. These funds currently provide a good alternative for investors who are looking to avoid volatile equities and are happy with an above-inflation return of 2% to 3%. However, if you move out of equities into these funds, just be aware that you will miss a sudden market correction (up or down) when it happens.
A combination of offshore index trackers, active funds that provide returns above the index, and income funds to give you downside protection against capital growth and above-inflation return, can prove to be a winning long-term combination in a living annuity.
By introducing income trackers, the total cost can be lowered. Legislation requires that you withdraw between 2.5% and 17.5% from your living annuity. I suggest you do this from a fund that has very little volatility; an income fund is a perfect fit for this.
It is not good practice to draw income from a volatile equity fund, as you deplete the funds faster during a dip in a market. You should then rebalance your exposure to the income fund annually as you withdraw funds.