Following three very challenging years in the local asset management industry, investors and investment professionals have been forced to reconsider the effectiveness of their investment strategies for living annuities.

1. HEDGENEWS AFRICA Fourth Quarter 2018 29
opinionInvestec Asset Management’s in-house research on Why Volatility
matters for living annuity investors draws two main conclusions.
These are:
1) Volatility is a core factor to consider in living an-
nuity investments
2) Active management can significantly impact in-
vestor outcomes, both by outperforming index
returns and achieving better risk characteristics.
Income-producing portfolios are much more
sensitive to portfolio volatility than conventional
capital growth portfolios. This is largely as a re-
sult of sequence of return risk – a phenomenon
whereby an income-producing portfolio is much
more sensitive to poor investment returns at
the inception of the investment, than to poor
investment returns towards the end of the in-
vestment term.
The research showed that given constant investment returns and
income drawdowns, increased volatility in the portfolio significantly
raises the risk of a living annuity failing over a 30-year period. In fact,
for living annuities with income levels of 2.5% to 6% per annum, the
following relationships appear to hold:
1) For every 1% additional real return produced by the investment
portfolio, the pensioner received around 0.9% per annum of ad-
ditional sustainable income
2) For every 1% reduction in the level of volatility of the investment
portfolio’s real returns, the pensioner could receive an additional
0.3% per annum of sustainable income
It is thus suggested that particular attention
should be given to the impact of unpredictable
markets on pensioners, focusing in particular on
the significant influence of portfolio volatility on living
annuity investors. It is also said that lower volatility
seems to ‘create’ additional returns for an income-
producing portfolio because it helps the portfolio
manage sequence-of-return risk more effectively.
Investec Asset Management concludes:
“We believe that it therefore makes sense for in-
vestors and advisors to consider investment
strategies with an inherent lower volatility for in-
come-producing portfolios such as living annuities.
Investment strategies that can deliver both strong
long-term real returns together with lower volatility can have a big
positive impact on these portfolios.”
To view the full article go to: https://www.investecassetmanage-
ment.com/south-africa/professional-investor/en-za/insight/living-
annuity-an-active-solution/
Why volatility matters
F
ollowing three very
challenging years in the
local asset management
industry, investors and
investment professionals have
been forced to reconsider the
effectiveness of their invest-
ment strategies for living an-
nuities.
The strong reliance of liv-
ing annuities on investment
growth to provide regular in-
come have made these invest-
ments particularly exposed to
the suppressed performance of
recent years, highlighting the
urgent need to improve the
ability of these portfolios to
support withdrawals.
In a recent article Why volatil-
ity matters for living annuity inves-
tors, Jaco van Tonder at Investec
Asset Management discusses
some of the core conclusions
drawn from their in-house re-
search on living annuities (see
box,below).
Traditionally hedge funds
were not considered as a vi-
able component to living an-
nuities as they were not easily
accessible to a wide range of
investors. However, since 2016
hedge funds have become
regulated under the Collective
Investments Schemes Control
Act (Act 45 of 2002), which
brought them into the over-
sight fold of the Financial Sec-
tor Conduct Authority and
available to all investors.
In addition to adding an al-
ternative source of return, an
appropriate combination of
hedge funds is able to act as a
low-volatility component in a
multi-asset portfolio and has
the ability to act as a strong re-
turn generator – exactly what
the research demands.
For example, the RCIS
THINK Growth QI Hedge
Fund, shown in blue, represents
a combination of hedge funds
specifically combined to act as
a building block to multi-asset
portfolios. The graph shows
that since inception the fund
provided investors with a high-
er return and lower volatility
than bonds (All Bond Index, in
red) and equities (JSE All Share
Index TR, in black) as well as
the vast majority of ASISA
General Equity (light grey) and
ASISA MA High Equity (dark
grey) unit trust funds.
A suitably blended hedge fund
portfolio can thus bring an addi-
tional component to the invest-
ment decision-making process
that demonstrates significantly
lower volatility than equities,
which over the considered four-
year period did not come at the
cost of lower returns.
An allocation to an appro-
priate combination of hedge
funds in a living annuity, there-
fore, presents an undeniable
opportunity to create sustain-
able income and demands seri-
ous consideration by investors
and advisors alike.
ElmienWagenaar, investment
manager,THINK.CAPITAL
The burden on living annuities
and how hedge funds can help
Jaco van Tonder
Sources:RealFin Fund Services,Morningstar