Being able to retire would be impossible if our investments didn’t beat inflation over time. The NewFunds ILBI ETF (NFILBI) invests in inflation-linked government bonds in an attempt to preserve your buying power.
As we explain here, inflation is when the prices of goods and services go up over time due to factors in the economy. For example, more buyers of a product limit supply, pushing the price up. Because prices go up, the same amount of money can buy less over time. This is a normal part of any economic system and not a conspiracy to keep you poor – however much it may feel like it.
Just like a company can raise money from the public by issuing shares, the government can borrow money from ordinary people by issuing bonds. We explain how that works here. When the government issues a bond, it agrees to pay back your money with interest. In the case of bonds, that interest is called a coupon, just to make it nice and confusing. Some bonds pay a fixed amount, and others pay an amount linked to inflation. For example, you can invest in a bond that pays out 1% above inflation. If inflation for the period was 5%, your bond would pay 6% interest.
The NewFunds government inflation-linked bond index (ILBI) is an index of all the bonds that the South African government issues that pays back interest linked to the consumer price index (CPI) – the index we use to measure inflation. The NewFunds ILBI ETF takes all the money you receive back from these bonds on a monthly basis and reinvests it in on your behalf. If you had invested in the bonds directly, that amount would have been paid out to you in cash. Because the ETF reinvests your money, the value of your investment increases by the coupon amount every time. When you’re ready to use your money, you sell the ETF units to get the benefit of the interest.
It may seem like this investment is the only one you’ll ever need, but bonds can complicate your tax return. The interest (or coupons) you earn from bonds are added to your income for the year and taxed at your marginal tax rate. While the ETF doesn’t pay the coupons to you directly, the reinvested coupons need to be added to your tax return. When you sell this ETF, you will realise a capital gain since the interest was reinvested. You already paid tax on the money you earned from this ETF, so you’d have to be careful not to pay tax twice. It’s advisable to speak to a tax expert or someone at SARS about the tax implications of investing in this ETF before pulling the trigger.
That said, if you are a cautious first-time investor with very little else by way of assets, this is the perfect ETF to ease you into your financial future.
Weekly expert: Mike Brown
Every week we ask an industry expert to explain the nitty gritty of our featured ETF. This week, Mike Brown from etfSA.co.za helps us understand the NewFunds ILBI ETF.
What sets the NewFunds ILBI apart from other ETFs?
This ETF follows a customised index that tracks a portfolio of South African Government Inflation-Linked Bonds. It comprises 10 inflation-linked bonds, which are linked to the South African consumer price indices (CPI). The inflation-linked bonds in the index have various maturities.
|3 – 7 years||37,13%|
|7 – 12 years||24,67%|
|Over 12 years||37,23%|
The capital value of the ILBI ETF increases in line with the increase in CPI, so the value of the investor’s capital is protected against inflation. The coupon, or interest rate, is also linked to inflation and increases in direct proportion to the local rate of inflation. The interest rate on inflation-linked bonds is typically lower than normal fixed interest bonds (currently between 2%-3% per annum), but the linking of this coupon to the inflation rate means a rising income over time.
The NewFunds ILBI ETF is a total return fund, which means that all interest received is reinvested back into the portfolio, so the investor receives a return based on the capital appreciation of both the bonds and the coupons, linked to the rise in inflation. The index is rebalanced monthly to take monthly inflation increases into account.
The link to the inflation rate is a clear differentiation. The return on the ILBI ETF is totally independent of what happens to interest rates or to other markets, it entirely depends on the escalation in the inflation rate.
As such, the NewFunds ILBI is a great product for diversification, it will show positive returns even when other markets are falling, so is a good hedge for multi-asset portfolios. It also protects the real value of the investor’s capital as it fully compensates the investor for any erosion of their capital by inflation.
Over time, in countries like South Africa, which have persistent increases in CPI, inflation-linked bonds can provide better long-term returns than nominal fixed interest bonds, as they do not suffer the capital gains or losses coming from rises and falls in interest rates. This lower volatility makes inflation linked bonds a much lower risk investment than many other assets.
What limitations should investors be aware of?
The NewFunds ILBI ETF will give consistent returns and protect the real value of money, but will not share in any bull run experienced in equity and fixed interest markets. But, the NewFunds ILBI ETF will not suffer any below inflation rate returns, which can beset other investment classes in bear markets.
Over time, even in medium inflation countries like South Africa, the link to inflation provided by the NewFunds ILBI ETF will provide consistent low risk real returns, which make such products an important component of portfolios.
What type of portfolio would benefit most from holding this ETF?
Most inflation-linked bonds are purchased by pension funds and insurance companies looking to protect their long-term liabilities to their clients/investors, who may only be drawing capital from an annuity or insurance policy well into the future. Inflation-linkers protect the real value of capital and, accordingly, the liabilities of the long-term investor.
However, such bonds, which are sold directly into the market by the Government, are not typically accessible to the retail investor. The NewFunds ILBI ETF makes this asset type available to smaller investors to use in their long-term discretionary investment or retirement annuity funds, in small denominations and at low cost.
Most financial experts would agree that any investment made for a period of five years or longer should hold about 10%-15% in inflation-linked bonds. The NewFunds ILBI ETF is the ideal vehicle for this portion of the asset allocation.
Unpacking the NewFunds ILBI ETF
|ETF name||NewFunds ILBI ETF|
|ETF issuer||NewFunds Collective Investment Scheme|
|Issue date||26 January 2012|
|ETF benchmark||South African Consumer Price Index|
|Tax-free savings account||Investment allowed|
|ETF major holdings||South African Government Inflation-Linked
|Performance||1 year +0.2%
3 year +7.2%
5 year +26.7%
|Coupons (Interest)||Reinvested monthly|
|What we like||This ETF has very little risk and tends to go up as long as prices increase. It’s a great product if you mind the tax.|
*12 April 2016