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Investment Strategy
Friday, February 1, 2002
Bonus warning

For the past three decades South African investors, just like most people worldwide, have become accustomed to an environment of high inflation and high interest rates. In such an environment prices are constantly rising and it’s normal to pay high interest on your home loan. On the positive side everyone expects higher salary increases as well as high investment yields.

Anton Gildenhuys, senior general manager of Product Management at Sanlam Life, says the current low inflation and low interest rates worldwide are positive for the economy. However, many people are not used to this and still have unrealistically high expectations regarding salary increases and investment yields.
  Lower interest rates in South Africa are not necessarily bad news for policyholders, whose assets are invested in shares, interest instruments and properties. True, returns on these assets have declined, but in nominal terms. Although bonus rates have decreased as inflation came down, bonuses have actually been much higher in real terms, according to Mr Gildenhuys.
He points out that low interest rates are presently a trend in the world’s leading economies. In the USA, inflation is currently about 1,9%, with a federal bank rate of 1,75% – the lowest since 1961. He says that in this economic environment policy proceeds of more than 5% a year can be regarded as a good investment return. “People who are used to an environment of higher interest rates must therefore now realise that lower inflation goes hand in hand with lower interest rates and lower investment yields.”
Bonus declarations are made annually by insurers on stable policies. These policies offer bigger guarantees and the exposure to the market is therefore less risky. Although stable policies offer steady growth over time, the bonus rates do not necessarily represent the actual growth achieved in a portfolio for a specific year. The rates that insurers declare in a specific year are an equalising figure, which means that the bonus does not reflect the full rises and falls of the investment markets’ volatility. In times of high returns a part of the actual growth is withheld for times of low actual returns, when it is once again added to equalise the returns over a number of years.
Mr Gildenhuys says it is nevertheless important that the value of the policy is not simply measured against the bonus rate, but rather against the extent to which it beats the inflation rate. For example, a bonus rate of 9%, if inflation is only 6%, is better than a bonus rate of 15% when inflation is running at 14%.
“It will only be possible to maintain the level of bonuses of a few years ago if South Africa were to return to a middle to high inflation economic environment. Although the 15% bonuses in the eighties looked good on paper, it’s important to remember that these were still only one or two percentage points above inflation.”
He says people who chose stable funds as investments for a specific reason should therefore be careful not to switch to market value funds for the wrong reasons or at the wrong time. “Stable funds should be kept for a longer term and are not suitable for regular switches.”
 

Copyright © Insurance Times and Investments® Vol:15.1 1st February, 2002
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