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By Sonia du Plessis*

Sonia du Plessis

With investors having to stomach highly volatile markets over the past few years, it’s easy to imagine that pensioners have nowhere to hide from value destruction. This isn’t entirely true, although rapidly rising prices have taken cash and money markets out of the equation because their returns aren’t keeping pace.

There’s never a one-size-fits-all solution, but if you’re retired and have some savings in low-return investments then you might want to consider an income fund.

This option won’t suit everyone, and returns aren’t guaranteed, but there are clear benefits to adding an income fund to your post-retirement investment strategy.

Who benefits most from an income fund?

You shouldn’t be surprised to hear that income funds are best suited to people who depend on earning an income from their investments. In most cases that would be retirees.

Investors in this age group are generally conservative in nature because they don’t want to put their future income at risk. This is also why money market funds have been so popular for more than a decade as South African investors have shied away from volatile or low-performing equities.

What are the benefits of an income fund?

Income funds aim to achieve a better than money market return while maintaining an extremely low risk profile.

The other main benefit of an income fund compared to an investment in the money market is that investors get daily pricing- meaning investors have a liquid investment, whereas money market accounts can have a lock-in period from days to years.

Investors in retirement, are especially sensitive to moves in the value of their investments, which is why they look for less volatile assets. However, with the cost of living rising rapidly, the returns from traditional safe havens like cash and money markets are struggling to beat inflation.

Income funds have a proven track record of outperforming money market returns.  Research shows that approximately R1,5trillion is sitting in South African retail bank deposits.  This is an enormous amount of money that can grow more in income funds- without taking on that much risk.

Brenthurst Wealth uses a range of income funds, two of the favourites, is the Mi Plan Enhanced Income fund and Ninety One Diversified Income fund.  The first mentioned has an incredible track record- being 1st in its fund class over periods from one to ten years:

Brenthurst also uses the Ninety One Diversified Income fund, see the graph below where the Ninety One Diversified Income fund has outperformed the money market for the past 10 years.

Source: Ninety One

If you’re one of the many South Africans with a fair amount of cash in your bank account or money market account because you fear market volatility, then an income fund is a far better option to retain your buying power.

An added advantage of income funds is that the management fees, usually between 0.75% and 1%, are much lower than equity funds.

What is an appropriate investment horizon?

To be clear, I’m not suggesting you shift your entire portfolio to an income fund.

But this option does make sense as a hedge against inflation if you’re risk averse. However, I do suggest that you stay invested in such a fund for at least 12 months to gain a meaningful benefit, and possibly another 12 more months if you can.

However, these funds can also be used by someone needing to park funds in preparation for a big purchase like a house. Holding your funds in a fund like this offers you the inflation hedge as well as liquidity to put your money to use when you need it most.

Unlike buying bonds directly, when the timing of your purchases or sales impacts your returns, income funds don’t have the same constraints. The fund manager is actively buying and selling bonds of various durations to maintain a balance within the fund to provide you with optimal returns.

How much income fund exposure do I need?

If you’re very risk averse, you might find the nature of income funds really appealing. However, placing 100% of your investments into income funds is not advisable.

For post-retirement investors, we would advise clients to keep at least 50% – 60% of their funds in equities. And as a general rule of thumb, we aim for a 10% – 30% allocation to income funds if you’re in retirement.

The reason that we suggest maintaining equity exposure is because it is the driver of investment returns, which you’ll need to beat inflation in the long run.

We all know that markets can be uncertain. If you can’t stomach that uncertainty but want to earn -money market-beating returns, then income funds really are your friend.

  • Sonia du Plessis, CFP®, is Head of Brenthurst Wealth Stellenbosch.