Managing living annuities to go the distance How to think about drawdowns, investment strategy and risk Shaun Duddy November 2017

The challenge we face Work Retire Retirement 55 - 70 ? 55 - 70 ? Each and everyone of us in this room faces a common challenge, which is ensuring that when your clients retire, they can enjoy an appropriate and sustainable real income throughout their retirement, however long that may be Achieving this requires a keen understanding of the risks you and your clients face, both in the build up to and during retirement, and how best to manage them

Discussion items Key risks and their implications Portfolio requirements Implementation So today, we will be discussing the key risks faced when drawing an income in retirement as well as their implications, and with that understanding, exploring the required characteristics for a portfolio to best manage those risks.

The key risks faced Not having enough saved at retirement… Risk Able to influence? Longevity No Inflation No Investment Yes It is often stated that the biggest risk is not having enough saved at retirement, and that’s true. But, enough is actually a function of what comes after retirement and how the risks during this period are managed. Now don’t get me wrong, there is definitely a point at which there is just too little, but an appropriate understanding and managing of post retirement risks can make less go a longer way. So what are the key risks… What is important to acknowledge at this point is that only one of these risks is really within your control. The potential impacts of inflation and longevity risks need to be understood but are essentially beyond your control, leaving portfolio construction as one of the few tools available for managing all three risks.

Longevity risk – Living longer and longer ASSA, South African Annuitant Standard Mortality Tables 1996 - 2000 A key consideration for any investment, is the investment horizon, and for retirement income this is determined by your client’s longevity… What this graph shows us is the probability of a client/couple aged 55 still being alive at different ages (disclaimers) And what is clear from this graph is that your clients’ funds need to last a long time, and longer still for greater certainty

Longevity risk – Years of income required 50% chance of still being alive 10% chance of still being alive Male Female Couple Male Female Couple 55 24 30 33 37 41 42 60 20 25 28 32 36 37 Current age 65 16 21 23 28 31 32 70 13 17 18 23 26 27 ASSA, South African Annuitant Standard Mortality Tables 1996 - 2000 But this is just for 55 year olds This table is based on the same data and gives an indication of how many years income may still be required for clients of different ages

Inflation risk Now whatever the period: IRESS Now whatever the period: a) Your client’s income needs to keep up with inflation over that time b) Their assets will need achieve returns in excess of inflation

Real returns required “My retirement savings are my most important investment – I can’t afford to take risks, and so I’ve put it all in the money market.” – Actual investor Real returns are a necessity, and as such, investment risk needs to be taken

Real returns required Starting annual income as a % of capital 3% 4% (rand income increasing each year with inflation) 3% 4% 5% 6% 7% 8% 10 - 10.6% - 7.6% - 4.7% - 1.1% 1.1% 3.2% 20 - 2.1% 0.0% 2.1% 3.8% 5.5% 7.2% Years of income needed 30 0.3% 2.2% 3.8% 5.4% 6.8% 8.2% 40 1.5% 3.1% 4.5% 5.9% 7.2% 8.5% Real returns required after fees, assuming no volatility. Real returns are a necessity, and as such, investment risk needs to be taken

Investment risk Risk of returns being lower than those required due to: Portfolio returns being lower than required over time Volatility and income redemptions at bad times

Historic long term real returns -1.5% for fees (plus VAT) Triumph of the Optimists

Real returns required Starting annual income as a % of capital 3% 4% (rand income increasing each year with inflation) 3% 4% 5% 6% 7% 8% 10 - 10.6% - 7.6% - 4.7% - 1.1% 1.1% 3.2% 20 - 2.1% 0.0% 2.1% 3.8% 5.5% 7.2% Years of income needed 30 0.3% 2.2% 3.8% 5.4% 6.8% 8.2% 40 1.5% 3.1% 4.5% 5.9% 7.2% 8.5% Real returns required after fees, assuming no volatility. Real returns are a necessity, and as such, investment risk needs to be taken

The impact of return timing 4% initial drawdown increasing with inflation of 6% p.a. 10% p.a. 6% p.a. 12.1% p.a. 12.1% p.a. 6% p.a.

The impact of return timing 4% initial drawdown increasing with inflation of 6% p.a. 3.6x

The impact of volatility 9.4% 72% Assumes a 4% initial drawdown (increasing with inflation of 6% p.a. each year) and an average return of 10% p.a.

Real returns required Starting annual income as a % of capital 3% 4% (rand income increasing each year with inflation) 3% 4% 5% 6% 7% 8% 10 - 10.6% - 7.6% - 4.7% - 1.1% 1.1% 3.2% 20 - 2.1% 0.0% 2.1% 3.8% 5.5% 7.2% Years of income needed 30 0.3% 2.2% 3.8% 5.4% 6.8% 8.2% 40 1.5% 3.1% 4.5% 5.9% 7.2% 8.5% Real returns required after fees, assuming no volatility. Real returns are a necessity, and as such, investment risk needs to be taken

Discussion items Key risks and their implications Portfolio requirements Implementation

Portfolio requirements Appropriate level of growth assets Focus on total returns & downside risk Help your clients understand their role Real returns Downside risk management

Appropriate level of growth assets Based on actual South African inflation, equity and bond returns over 30 year periods since 1900 .

Drawing from the money market 92% Allan Gray Balanced Fund, 8% Allan Gray Money Market Fund (AGMF) Allan Gray Balanced Fund (AGBF) Money market + bank deposits Net equity Foreign Bonds Commodity-linked Property All of the following slides assume 4% initial drawdown, increased by inflation

Drawing from the money market – at the start Better 13% Worse 87% Assumes a 4% initial drawdown, increasing with inflation each year

Drawing from the money market – over time Better 3% Worse 97% Assumes a 4% initial drawdown, increasing with inflation each year

Drawing from the money market – over time Excess market value - 2 years income in AGMF replenished 2 yearly vs. 4% in AGMF Assumes a 4% initial drawdown, increasing with inflation each year

Income returns vs. total returns

Income returns vs. total returns

Income returns vs. total returns

Income returns vs. total returns 4% initial drawdown increasing with inflation of 6% p.a. 20%

Discussion items Key risks and their implications Portfolio requirements Implementation So today, we will be discussing the key risks faced when drawing an income in retirement as well as their implications, and with that understanding, exploring the required characteristics for a portfolio to best manage those risks.

Considering the Allan Gray Balanced Fund Excludes Orbis Optimal and Orbis Global Balanced equity exposure

Considering the Allan Gray Balanced Fund Value of business measured by share price Intrinsic value of business Margin of safety Buy here Extreme events Sell here Value Time

Considering the Allan Gray Balanced Fund

What if a client can’t afford to self-insure? Self-insuring (LA) Insured (GA, WPA)

Key takeaways Prepare for clients to live a long time 30 years or more Invest for real returns At least 50% in equities Actively manage downside risk Starting drawdown should not be more than 4% Acknowledge when self-insuring is out of reach

Thank You