From RSA with love – Retail Bonds
While I have stolen the idea for the title of this article from an onscreen icon, I will refrain from going into too much of a cheesy metaphor related to the suave, Walther PPK toting, British secret service agent.
Suffice to say that the similarities begin and end with the name – Bond.
In truth there is nothing sexy about RSA Retail Bonds. They exhibit none of the “sex and violence” traits that make for a captivating storyline or sales pitch. They offer none of the adrenalin pumping excitement often associated with stock-picking, where the promise of great riches creates a world of heroes (Apple Inc) and villain’s (African Bank).
It is precisely this boring predictability that makes the RSA retail bond my investment of choice in many circumstances and here are my reasons why I think you could consider them too:
(i) They offer better yields than conventional government bonds:
Most of the domestic bond funds you can invest in will have a majority allocation to South African government bonds (Govvies) of various maturities. The RSA retail bonds (RSA RB) pay a better rate than all of the similar dated conventional bonds and frequently better than most of the longer-dated equivalents too:
Without getting too technical, in “bond speak “ the longer you lend money for, the more you would expect to be paid – it is riskier to loan money over long periods and longer dated bonds have a greater sensitivity to changes in interest rates (duration). Retail bonds currently show there is an exception to this rule, from time to time, so we should take advantage of that.
While the magic of compounding is only really useful over long periods, the 5 year bond (8%) with income reinvested, will give you an effective yield of 8.16% per year over the five years or a cumulative 48% return. Not to be sniffed at in the context of current interest rates and some relatively fully valued equity markets.
(ii) They offer better yields than the banks:
RSA Retail Bonds are issued by the South African government and not a bank or other financial institution. In most cases the banks would be expected to pay a higher yield or a premium to lend money from us relative to the government (In fact this holds true if you compare the banks 3-year fixed deposit accounts with the standard 3-year Govvie). But the SA Treasury is showing us retail savers a bit of love by offering a better return than most banks equivalent fixed deposit accounts:
(iii) They are low cost and easy to manage:
The RSA retail bond platform on which you purchase your bonds is absolutely free, gratis, mahala. It does not get cheaper than that and an investment can be set-up and monitored online. There are no hidden annual admin charges. There are no charges for reinvesting the income or making payments from your account. Unlike with the banks there are no requirements to hold other fee paying accounts, keep minimum balances or have minimum contributions. Whether you invest R1000 or R5,000,000 you get paid the same rate as everyone else.
(iv) The after tax yields are better than savings accounts pre-tax yields:
They are interest income producing assets which means you will be taxed at your marginal rate after you have utilised your annual allowances (R23,800 for individuals under 65 and R34,500 for those older than 65).That means you can invest up to R297500 as someone younger than 65, with income fully distributed without paying tax on that income each year. If you are older than 65 you can invest R431,250 under the same terms.
But even at a marginal tax rate of 40%, the after-tax yield on the 5 year retail bond is still 4.8% which will beat the pre-tax yield of about 99% of instant access savings accounts at the bank. That could be food for thought for those of you holding long-term cash positions in your bank accounts.
This is often cited as the main drawback of the RSA Retail bonds. These bonds are not tradable on a secondary exchange which means once you have bought them you must hold them for the duration of the term. After a year you may access your money but you will be penalised. This is similar to the offerings from fixed term accounts at the bank. I have no problem with this as it promotes discipline and averts the cheeky dip into savings from time to time.
(vi)They give you a free option:
One of the most unique characteristics of the RSA Retail Bond, and a very compelling one at this stage in the interest rate cycle, is the RESET OPTION. Basically the Treasury is saying invest in a bond at an agreed fixed rate. After 12 months if the rate is higher we will give you the option of switching to that higher rate by re-setting your investment. Most financial institutions would charge you a hefty fee for this option but our friends at the treasury illustrate the willingness to promote savings by giving it to you for free.
(vii) They currently offer the best real yields (Inflation beating):
This graph illustrates once again that the best real yield (after inflation) is available in the 5-year retail bond which, at 2.2%, gives you more than twice as much as the current yield on the equivalent Govvie. The 2-year retail bond has a real yield almost 3x that of the 2-year Govvie.
It should be noted here that you can also invest in inflation-linked RSA retail bonds. Unfortunately there is too much to cover in detail in this write up but the choice to go fixed or inflation-linked depends on current pricing, your time horizon and your future inflation expectations.
Other important points to consider:
I am not advocating RSA retail bonds as the Holy Grail of investment options which will suit all circumstances. They are not instruments for creating long-term wealth. If you have a long-term time horizon and no need for income then you should focus on equities and property related investments which over the long term should provide you with the best real returns.
However, if you have a defined goal with a 5-year or less time horizon you can potentially match your future liability with absolute certainty. Unlike with a share purchase, the beauty of a bond is that you know right upfront what cash flow (payments) you will receive and when you will be getting them.
If you are already in retirement and looking for regular known payments these may be worthwhile too – Over 60’s can opt for monthly payments rather than the semi-annual payment for everyone else.
These bonds are, as the name implies, only available to individual South African residents. So you cannot buy them in a trust, partnership, as a company, collective investment scheme or as a non-resident. (I believe it is mostly as a result of this restriction that the yields available on these bonds are still so attractive).
There is a maximum limit of R5000,000 per individual – Not a huge problem for most of us unfortunately.
You cannot make regular monthly contributions into an RSA retail bond. They are designed to be set up as a single investment. Any future contributions will be dealt with as a completely separate investment. (All visible under your one account name and login of course though).
You can opt to get paid out your interest or you can have it reinvested and compounded over the life of the bond. If you are over 60 you can also opt for monthly rather than semi-annual income distributions.
You can (and always should) nominate beneficiaries to avoid the executor fees for estate planning purposes. Note they will still be subject to estate duty.
RSA retail bonds are certainly not an investing panacea but they are often over looked relative to other more mainstream (and well marketed) options. If you would like to find out more about RSA Retail bonds you can visit their website or get hold of White Investments who can help you incorporate these instruments into a successful investment strategy.
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