By Isaack Veii, National Sales Manager, Corporate Segment, Old Mutual Namibia

There has always been uncertainty in markets. Recent negative investment returns, coupled with increased inflation and rising interest rates, have not helped much in easing the minds of investors. So, what should investors do? Should investors ‘de-risk’ by moving to money market investments or should they wait until the market, or conditions affecting the market, stabilize to invest again? The simple answer is: “None of the above!” 

When investing, one needs to spend time in the market rather than trying to time the market. Despite being surrounded by uncertainty, investors need to plan and save for their future needs, and this means that inflation-beating returns should be top of mind.

Inflation is the general increase in the price of goods and services and an equal fall in the purchasing value of money. This effectively means that the buying power of an individual diminishes over time. So how does one keep up with inflation when it comes to investments: By investing in growth assets. Balanced funds provide their investors with exposure to growth assets such as equity, property, and alternative assets both local and global. The problem with growth assets, however, is that they are deemed to be riskier than other assets. Why? Their returns are more volatile than those of other investments.

Volatility is the measure of increases and decreases in returns over a period. In simple terms, this means that growth asset returns move up and down more frequently and to a larger extent than the returns of other assets. This means that there is a possibility that at your date of retirement, financial markets could be in a depressed state, leaving you worse off than expected. Managing this volatility is thus important when it comes to investing for retirement. Smoothed Bonus Funds provide inflation-beating returns while still managing volatility.

What is a Smoothed Bonus Fund?

Smoothed Bonus Funds (SBFs) are long-term investment portfolios that use smoothing to target the distribution of stable, inflation-beating returns to investors over the longer term, while significantly reducing the volatility associated with market-linked investments.

The underlying investment portfolio that SBFs invest in ranges from Conservative to Aggressive Balanced Funds. These portfolios usually provide exposure to local and global investment markets as well as alternative assets, such as private equity, natural resources, infrastructure and/or development finance, that meet Environmental, Social and Governance (ESG) related factors.

How does a Smoothed Bonus Fund work?

SBFs aim to provide the investor with smoothing throughout the journey to retirement by catering for both growth and protection of capital. The investment returns targeted by SBFs usually range between 2% and 6% above inflation.

As the portfolio grows, excess returns flow into a Bonus Smoothing Reserve (BSR). These excess returns are used to top-up returns allocated to SBF investors when growth assets are recording low/negative returns. This process is referred to as ‘smoothing.’  It ensures that investors experience consistent growth while their investments are protected from losses recorded during periods when markets crash. This provides investors with peace of mind throughout the journey, should they disinvest at a stage when the market is performing poorly.

Most SBFs also provide capital protection. Capital protection provides the investor with the assurance that his/her investment will not reduce by more than the guarantee that has been purchased. For example, if an 80% capital guarantee is selected and N$1 000 000 is invested, the investor is guaranteed that the investment will not reduce to less than N$800 000. Any returns allocated to the investor are also guaranteed in this manner. So, if a return of 10% is allocated to the investment of N$1 000 000 the investment value grows to N$1 100 000 and the investment is guaranteed to not reduce to less than N$880 000. Should a 100% guarantee be selected, the investment plus interest is fully guaranteed.

An insurance premium, more commonly known as a ‘capital charge,’ is levied on the investor to cover the cost of the capital protection. The higher level of capital protection, the higher the capital charge will be.

Important considerations pertaining to SBFs

As for most insurance products, the insurer sponsoring an SBF must protect its policyholders and shareholders from anti-selection. Anti-selection occurs when a party acts on known information to gain an advantage in either securing or denying an insurance policy. To achieve this, the insurer sets limits on the extent to which guarantees are maintained. These are generally related to the reason for investment/disinvestment. For example, the guarantees will continue to apply with respect to investments and disinvestments arising from contractual commitments and/or life events that are unrelated to the performance of the investment market (for example, termination of employment due to resignation, death, or retirement).

Who should invest in a Smoothed Bonus Fund?

SBFs are ideally suited for:

  • Retirement fund members that are uncomfortable with the concept of volatile returns.
  • Retirement fund members who are within three to five years of retirement and desire to have some protection on their retirement capital.
  • Retirees that have purchased living annuities.