Not the time to relax risk appetite
In his 1988 annual letter to shareholders, Warren Buffett wrote: "We have no idea how long the excesses will last, nor do we know what will change the attitudes of government, lender and buyer that fuel them. But we do know that the less the prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs." He was referring here to Berkshire Hathaway’s arbitrage activities, but I believe that investors would do well to heed these words today.
Most investors admit to worrying about how the massive intervention by most governments and central banks will end. What will be the long-term costs of today’s runaway government spending and central bank balance sheet expansion? Many investors in South Africa are concerned about the poor performance of our productive industries, and they worry about how the declining trend can possibly be reversed in the face of rapidly rising electricity prices, poor educational outcomes and fractious labour relations. In light of Mr Buffett’s advice, does all of this worrying justify contrarian bullishness?
We argue not. We prefer to focus on what people are doing rather than on what they are saying. The distinction is important, because it seems that there is some disconnect between the two. US investor and author Howard Marks observed in his recent memo to Oaktree clients that ‘while few people are thinking bullish today, many are acting bullish.’
Proceed with caution
There are a number of objective measures indicating that despite a laundry list of worries, ‘Mr Market’ is today conducting his affairs with somewhat less prudence than perhaps he should.
The inflation-adjusted ‘Shiller’ P/E ratio on the S&P500 is 22 compared to its long-term average of 16 (see Graph 1). The Shiller P/E measures the ratio of the S&P500 index to average annual profits over the preceding 10 years, and is thus used as an objective indicator of the multiple one is paying for ‘normal’ profits. The inflation-adjusted Shiller P/E ratio on the FTSE/JSE All Share Index (ALSI) is 19 compared to its long-term average of 14, as reflected in Graph 2. On this measure, equity valuations are higher than normal – indicating that we should be cautious, for the very reason that others are acting less cautiously. The CBOE Volatility Index (VIX) is close to its lows over the last two decades. The VIX is a measure of investors’ expectations for future equity market volatility over the next 30 days, derived from the pricing of options contracts. The current low reading on the VIX suggests that investors are now almost as complacent as they were before the global financial crisis of 2007/08. The debt markets too are sending signals of slipping prudence: 2012 was a record year for the issuance of new high yield bonds in the US, and private equity firms are again using the aggressive leverage that they were using prior to the crisis. Yields on fixed income securities globally are very low.
These measures are affirmed by the record low reading on the Leuthold Group’s Monthly Risk Aversion Index (RAI), which was recently published in Bloomberg Businessweek. This is a composite indicator which combines various credit and swap spreads, commodity and currency prices, and relative asset returns ‘to offer a broad gauge of skittishness’.
Maintain your risk standards
These indicators all suggest that caution is called for if we are to follow Mr Buffett’s advice. But acting prudently while many around you are not is hard to do, because it can result in years like we just experienced in 2012 – years in which satisfactory absolute returns lag behind peer benchmarks. Investors should be careful not to unconsciously lower their risk standards in a chase for yield. Spells of short-term under-performance are the price one pays for long-term out-performance.
We believe that the current relatively conservative positioning of our portfolios is appropriate in light of current prices and is the best way to maximise long-term returns.
Commentary by Ian Liddle, Chief Investment Officer, Allan Gray.
Make financial planning a priority in 2013
Research from the US shows that financial planning
is a critical factor separating those who are on track to meet their financial goals and those who are falling behind. With the beginning of a new year traditionally a time of resolutions, why not make financial planning your priority in 2013?
Having a plan and a process in place to achieve your goals is key.
But where to begin? People often make the mistake of asking which product they need without realising this is the wrong place to start. The critical starting point is your longterm plan. A plan is like your destination; it gives you an idea of where you want to land up. It forms the foundation of all your decisions. Once your plan is in place you can establish a process to follow that plan. The process deals with how you will reach your destination and achieve your goals. The final step is choosing your product. Inverting the triangle in the illustration makes no sense as you cannot choose an appropriate product until you know what you want to achieve. Answering some key questions is an excellent starting point and will give your plan some structure:
How long do I want to invest for?
Being clear on your timeframes is important as some investment products have restriction periods – and you don’t want to get into a situation where you cannot access your money. Additionally, different asset classes (i.e. shares, bonds, property, cash) are suitable for different timeframes. Your investment horizon is determined by your goal, e.g. the length of time until your children start university or the number of years until you would like to retire, versus if you need to start an emergency fund, or have lifestyle goals, such as buying a new car or taking a trip. Generally, the longer you have to invest the more flexibility you have in terms of how much risk you can afford to take.
What’s my attitude to risk and potential returns?
You need to decide how much risk you are prepared to take on to achieve your desired returns. Think about how comfortable you are with losing money (on paper) over the short term in order to achieve returns in the long term. Put differently, how much short-term stability are you prepared to sacrifice to increase your chances of achieving better long-term returns. Understanding your risk appetite will help you when you have to make asset allocation decisions. Asset classes with the potential for greater returns come at the expense of increased risk of capital loss as well as increased short-term volatility. Therefore, if you want to enjoy the benefit of a greater lifetime income, you must be prepared to tolerate both these risks.
Do I want capital growth or income, or both?
Your choice of investments depends on whether you want your savings to increase (i.e. give you capital growth), or give you regular payments (income). This is something else to factor into your asset allocation decisions. Getting the asset allocation balance right is difficult. Before you begin, you should consider how much growth you need to sustain your investment and how much risk you can afford to take. Based on this, you should look for assets that offer long-term growth potential, and allocate capital to these assets based on your risk appetite and ability to handle decreases in income.
Only once you have answered these questions can you begin to look at products that may meet your needs. Starting with your plan means achieving clarity about personal financial goals.
An independent financial adviser can help you formalise your plan and choose products and funds that are well suited to your circumstances. Remember though, you need to regularly revisit your plan to make sure you are on track to meet your goals, and to make sure your goals still work for your reality.
Commentary by Jeanette Marais, Director of Distribution and Client Services, Allan Gray.
The new Dividend Withholding Tax (DWT) replaced Secondary Tax on Companies (STC) on 1 April 2012. Investors are understandably concerned about the long-term impact of this tax and the real effect on their investments. Allan Gray's research shows that although the change in the way dividends are taxed will impact your investment, the net effect of the latest change is relatively small. Any possible benefit or disadvantage should ultimately be weighed against your objectives, circumstances and risk profile, which should form the basis of your investment
planning. As always, if you need help with your investment planning you may wish to speak to an independent financial adviser
What are the key points?
Under STC companies were taxed on dividends distributed at a rate of 10%. With the recent changes, the liability for tax on dividends has shifted to the investor and the rate has increased to 15%. Because the new tax is deducted from the dividends received, rather than paid by the company on top of dividends, the effective increase in the rate is slightly higher than 5%. The effect of these changes on existing investments, or investment planning, depends on the underlying unit trusts as well as the investment product.
Only a portion of your investment is affected
All other things being equal, the impact of the change in tax will be to reduce dividend income by a total of 6.5%, which will clearly make a difference to those relying on dividend payments. But investment return is not just made up of dividends distributed by equities, it also includes capital growth and income from interest earned. As its name suggests, DWT only affects the dividend portion of your investment’s overall return. Therefore, the impact on your investment will differ depending on your asset allocation.
The effects of replacing STC with DWT are minimal in a well-diversified discretionary investment, but may be more marked for investors seeking to benefit from the potential for higher capital growth and associated higher dividend yields from equities. Table 1 compares illustrative five-year investments into an asset allocation portfolio and an equity-only portfolio, taxed at 10% STC and 15% DWT. Allan Gray used five-year returns to 31 March 2012 of the FTSE/JSE All Share Index (including income and gross of all tax) (ALSI: 7.53%), the All Bond Index (ALBI: 8.75%) and the Short-term Fixed Interest Index (STeFI: 8.4%) to represent performance in our example. Over this period, dividends made up 3.29% of the ALSI’s total returns. In this scenario, the impact of the change in tax on the final values is very small, even over a five-year period.
Table 1: Final value of a R1 000 discretionary investment over five years
| || STC ||DWT|
| Asset allocation portfolio|| R1,455|| R1,449|
| Equity-only portfolio|| R1,417|| R1,407|
*Asset allocation: 60% ALSI, 25% ALBI, 15% STeFI
**Equity-only: 100% ALSI
Source: Allan Gray research
Retirement fund investors benefit
If you are a retirement fund investor (i.e. you are invested in a retirement annuity, living annuity and/or preservation fund), you will benefit from the change from STC to DWT. This is because retirement fund investors do not pay any tax on returns and the shift to investor liability for tax on dividends effectively removes this tax for these investors. Even for a retirement fund or a member of a fund with the maximum amount in South African equities the saving will be, once again, fairly small – under the same assumptions above, Allan Gray calculate a difference of less than 2% in final value.
DWT affects unit trusts’ reported historical performance
Unit trusts management companies often include reinvested dividends in the calculation of unit trust return. In the past, these dividends would have been paid from profits that were reduced by STC. Since the introduction of DWT shifts the tax liability to the investor, although reinvested dividends will still be included, the effect of the tax will not be shown. This means that reported unit trust returns, specifically for high dividend yield unit trusts, may be marginally higher than the after tax-return many investors experience. This is consistent with the impact of capital gains tax and income tax on interest earned in unit trusts.
Members are now able to retire from their individual investment accounts within the following retirement funds:
- Allan Gray Retirement Annuity Fund
- Allan Gray Pension Preservation Fund
- Allan Gray Provident Preservation Fund
Previously, members who had multiple investment accounts within the same retirement fund were required to retire from all of their investment accounts at the same time.
Requirements to retire from an individual investment account:
- Members can retire from one or more of their investment accounts at any stage after age 55.
- Members cannot partially retire from an individual investment account.
- The minimum retirement amount is R150 000. Members retiring across all their investment accounts in the same retirement fund do not need to meet this minimum.
- The remaining balance after retirement needs to be R150 000 across the remaining investment accounts.
Members cannot defer their one-third cash lump sum benefit
Members retiring from the Allan Gray Retirement Annuity and Pension Preservation funds can take a maximum cash lump sum benefit of one-third of their investment value in the investment accounts that they are retiring from. If they would like to access this benefit, they will need to do so at the point of retiring from their investment accounts and cannot defer it until their next retirement from the fund.
The Minister of Finance’s 2012 budget speech contains various amendments to tax and other legislation that may affect
investors. These are:
Tax thresholds have been amended to:
- Income above R63 556 for taxpayers younger than 65
- Income above R99 056 for taxpayers aged 65 and below 75
- Income above R110 889 for taxpayers aged 75 and above
Rebates deductible from tax payable have been amended to:
- R11 440 per year for all individuals (primary).
- An additional R6 390 for taxpayers aged 65 and above (secondary).
- An additional R2130 for taxpayers aged 75 and above (tertiary).
Interest and dividend income exemptions remain the same:
- The annual exemption on interest earned for taxpayers younger than 65 stays unchanged at R22 800
- The exemption for taxpayers aged 65 and older stays unchanged at R33 000
- The threshold for the tax-free portion of interest and dividends from foreign investment stays unchanged at R3 700
Tax-free lump sum on retirement
The tax free lump sum has been left unchanged at R315 000. The table below illustrates how lump sums on retirement continue to be taxed:
Taxable lump sum
Rate of tax
| 0 - R315,000|| 0%|
| R315,001 - R630,000|| R0 + 18% of amount exceeding R315,000|
| R630,001 - R945,000|| R56,700 + 27% of amount exceeding R630,000|
| R945,001 and above|| R141,750 + 36% of amount exceeding R945,000|
Dividend Withholding Tax
As expected, the replacement of secondary tax on companies (STC) with dividend withholding tax (DWT) will be implemented on 1 April 2012.The tax, generally expected to come in at the same level as the STC rate of 10%, will now be levied at a rate of 15%.
The increase in the rate was explained on the basis that it will help to mitigate some of the revenue losses when switching from STC to the new DWT. The estimated net loss as a result of these changes was valued at R1.9 billion.
Transitional STC credits initially expected to last up to five years will be reduced to three years.
Capital gains tax
To enhance equity and to bring SA more in line with the practice in developed countries, effective capital gains tax rates
will be increased.
CGT for individuals and special trusts will increase from 25% to 33.3%. This increases the maximum effective tax rate from 10% to 13.3%. The rate for companies and other trusts will increase from 50% to 66.6%, increasing the effective rate from 14% to 18.6% for companies and 26.7% for other trusts.
To limit the impact of the CGT increase on middle-income households, the exemption thresholds for individual capital gains and for primary residences have been adjusted significantly.
The annual exclusions for net capital gains will change as follows:
- For individuals and special trusts from R20 000 to R30 000 a year
- On death from R200 000 to R300 000
- On disposal of a small business when a person is over 55 years old from R900 000 to R1.5 million
- The primary residence exclusion from R1.5 million to R2 million
All the above changes will come into effect from 1 March 2012.
Due to South Africa’s low household savings rate, consideration is being given to the introduction of tax-exempt short
and medium-term savings products. It is hoped that these products are going to encourage voluntary savings. The proposal is that individuals should be permitted to save up to R30 000 a year, with a lifetime limit of R500 000, in registered savings or investment products that would be free of tax on interest, dividends or capital gains. The maximum limit of R500 000 is to ensure that high net worth individuals do not benefit disproportionately. Treasury also said that the design and costs (banking and other fees) of these savings and investment vehicles may be regulated to help lower-income earners to participate. The current tax free interest income thresholds will be reviewed and possibly phased out as part of this reform.
Government is planning to introduce these changes on 1 April 2014 and will publish a discussion document in mid-
The proposed retirement reforms that were mentioned in last year’s Budget Speech were revisited this year with some adjustments. Contributions by employees and employers to pension, provident and retirement funds will be tax deductible by individual employees at a rate of 22.5% of the higher of employment or taxable income for individuals below 45 years of age and 27.5% for those above 45.
Annual deductions will be limited to R250 000 and R300 000 per annum respectively and a minimum monetary threshold of R20 000 will apply to allow low-income earners to contribute in excess of the prescribed percentages. Nondeductible contributions (in excess of the thresholds) will be exempt from income tax if, on retirement, they are taken as either part of the lump sum or as annuity income.
These amendments are envisaged to come into effect on 1 March 2014.
Last year’s proposal to subject lump-sum withdrawals from provident funds to the one-third limit that applies to pension funds and retirement annuities was not mentioned or expanded upon.
It was also mentioned that the Department of Labour would establish a provident fund for domestic and farm workers by
March next year.
National health insurance:
National health insurance is to be phased in over a 14-year period beginning in 2012/13. The new system will provide
equitable health coverage for all South Africans.
Over time, the new system will require funding over and above current budget allocations to public health. Funding
- An increase in the VAT rate,
- A payroll tax on employers,
- A surcharge on the taxable income of individuals, or
- A combination of the above.
Alongside options for increased tax revenue, the role of user charges is also being investigated. A discussion paper will
be published by end-April 2012.
New and interesting
As part of the global response to mitigate climate change, a revised policy paper on a carbon tax will be published this year for a second round of public comment and consultation. As set out in the Climate Change Response White Paper approved by Cabinet in 2011, the need to price carbon emissions and the phasing in of a tax instrument for this purpose are accepted.
Tax on financial transactions
From 1 April 2013, the exemption from Securities Transfer Tax (STT) for brokers who acquire shares for their own benefit will be abolished and instead broker transactions (including buying shares used in derivative hedging) will merely be taxed at a lower STT rate. The base of STT may also be broadened to include derivatives.
The Tax Administration Bill has been approved by Parliament. It incorporates the common administrative elements of current tax law into one piece of legislation, and makes further improvements in this area. The bill is expected to be promulgated and most of its provisions brought into force in 2012.
During 2012, South Africa will establish a dedicated Ombud for tax matters. The office is intended to provide taxpayers with a low-cost mechanism to address administrative difficulties that cannot be resolved by SARS.
Review of tax system for insurers
The principles of the four fund trustee system of taxation relating to long-term insurers will come under review. Longterm insurers hold and administer assets on behalf of various categories of policyholders, in addition to managing assets for the benefit of shareholders. In recognition of these relationships, long-term insurance products are subject to the four funds system, with the insurer being taxed on returns on assets as trustee for the policyholder. However, once the system moves beyond basic theory, it is often unclear whether issues should be determined from a policyholder perspective or a corporate shareholder perspective, and how the two perspectives can be combined.
A short paper on long-term insurers will be circulated for comment by mid-2012.
Some general comments
Financial sector development
The financial industry has been urged to take more urgent steps to reduce costs and introduce more appropriate and transparent saving and investment products, including annuities. Treasury believes that fees for many products in the financial sector remain too high and that the high costs in savings products undermine the national objective of getting more people to save.
Treasury believes that there is also much to be done to improve market conduct practices in the financial sector. The
‘treating customers fairly‘ initiative will be accelerated to protect customers more vigorously.
Tax treatment of medical expenses
The medical tax credits mentioned in last year’s Budget Speech as a more equitable form of relief than medical deductions will come into effect from 1 March 2012.
For individuals under 65 years the tax credit for contributions to medical schemes will be introduced at a rate of R230 a month for each of the first two beneficiaries and R154 for each additional beneficiary. Any medical scheme
contribution in excess of four times the total allowable tax credits, together with out-of-pocket medical expenses, may be claimed provided that the total exceeds 7.5% of taxable income.
Individuals 65 years and older and taxpayers with disabilities currently claim all medical scheme contributions and outof-pocket medical expenses.
Tax on gambling
Following last year’s Budget Speech proposal on gambling, it is proposed that a national tax based on gross gambling revenue should be introduced. This will be done as an additional 1% levy on a uniform provincial gambling tax base. A similar base will also be used to tax the national lottery.
This will be effective from 1 April 2013.
Estate Duty, Donations Tax and Transfer Duty
The limits associated with the above remain unchanged.
During his recent budget speech, Minister of Finance Pravin Gordhan, announced that Dividend Withholding Tax (DWT) will be levied at a rate of 15% when it is implemented on 1 April 2012. This is an unforeseen increase on Secondary Tax on Companies (STC), which it is set to replace, and took Allan Gray and most other stakeholders by surprise.
Gordhan explained that the increase in the tax rate will make up for some of the R1.9 billion in losses expected as a result of those groups who are exempt from the tax (see point 3). It is hoped that the introduction of DWT will improve the transparency and equity of our tax system, and ultimately align South African practices with international norms.
With DWT set at 10%, the transition from STC to DWT would have gone unnoticed since it merely involved a shift in the tax liability on a dividend distribution from the company paying the dividend to the investor receiving it. With DWT now set at 15% (It was originally thought to be at 10%) it may impact South African individuals, trusts, and non-residents, the latter where there is no or limited protection under a Double Taxation Agreement (see point 3).
1. What is Dividend Withholding Tax?
DWT is a 15% tax levied on investors receiving dividends declared and paid by South African resident companies or foreign companies listed on the JSE. Although DWT is a tax borne by investors, it is the responsibility of the companies paying the dividends, or where relevant, certain ‘withholding agents’, to withhold the tax and pay it to the South African Revenue Service (SARS) on behalf of the ultimate recipients.Allan Gray Unit Trust Management (RF) Proprietary Limited and their investment
platform, Allan Gray Investment Services Limited, are examples of ‘withholding agents’. They must therefore pay the tax to SARS on behalf of their investors.
2. What does this mean for you?
a. The new dividends tax is a final withholding tax set at 15% on dividends paid
This means that if a dividend of R100 is paid, the recipient will receive R85 and SARS R15. The dividend income (R100 in the above example) will still be exempt from normal tax in the beneficiary’s hands because the dividends tax does not influence the normal tax rules. The 15% will be the final tax payable on the dividend.
b. Taxation of distributed profits moves from company level to investor level
The difference between DWT and STC is that DWT is a tax levied on investors who receive dividends, whereas STC is a tax payable by the company declaring the dividend. The legal liability for tax on a dividend distribution therefore shifts from the company paying the dividend to the investor (also known as the ‘beneficial owner’) receiving it.
3. Some investors are exempt from DWT
Certain investors are exempt from DWT, including:
- South African resident companies or close corporations
- The South African government, provincial governments and municipalities
- Specified tax-exempt beneficiaries (e.g. public benefit organisations)
- Retirement funds and living annuity policyholders
- Endowment investment accounts allocated to the Company Policyholder Fund or the Untaxed Policyholder Fund
If you are a non-resident, the rate at which we will deduct DWT will be determined by the Double Taxation Agreement (DTA) that exists between South Africa and your country of residence. However, most DTAs only allow for a reduced tax rate if your investment is held in the name of a registered legal entity (e.g. a company) and you own a minimum percentage of share capital (typically between 10% and 25%) in the South African company declaring the dividend. For unit trust investors, these requirements are unlikely to apply.
The Minister of Finance has announced that Dividend Withholding Tax (DWT) will replace Secondary Tax on
Companies from 1 April 2012.
Your investments will not be negatively affected in any way
Under the current STC system, the company declaring a dividend is responsible for paying tax on dividends to
SARS before distributing them to investors. Under DWT, investors will be responsible for paying tax (i.e. DWT) to
SARS via an ‘agent’, such as Allan Gray. Allan Gray will deduct DWT from your dividends and pay it to SARS on
your behalf. Allan Gray will distribute the remaining balance to you as either a cash payment or additional units in
your investments (where applicable).
Only clients invested in the following products will be required to pay DWT:
- Allan Gray Unit Trusts
- Allan Gray Investment Platform (local investments only)
- Allan Gray Endowment (Individual Policyholder Fund)
Certain clients may qualify for a reduced tax rate
For non-residents, the rate at which Allan Gray will deduct DWT will be determined by the Double Taxation Agreement
(DTA) that exists between South Africa and your country of residence. However, most DTAs only allow for a
reduced tax rate if your investment is held in the name of a registered legal entity (e.g. a company) and you own
a minimum percentage of share capital (typically between 10% and 25%) in the South African company declaring
the dividend. For unit trust investors, these requirements are unlikely to apply. However, certain individual
investors and organisations may qualify for a reduced rate if you are registered as a tax payer in one of the
Country China Cyprus Ireland Malta Oman Seychelles Kuwait
Rate 5% 0% 0% 5% 0% 0% 0%
This table is not an exhaustive list and may change from time to time.