Sanlam tax efficient cash funds: FAQ

Guide to Sanlam’s tax efficient cash funds

From time-to-time, we receive various questions on Sanlam’s tax efficient cash funds, the Sanlam Alternative Income Fund (SAIF) and the Sanlam Diversified Income Fund of Funds (SDIFOF). These questions include “What makes these funds more tax efficient?” and “How do you calculate the after-tax return for these funds?”. We have collected these various questions, with answers, available to you via the below. We hope you will find the information useful and insightful.

1. What is the difference between SAIF and SDIFOF?
Both funds are conservative with capital preservation front of mind. Offering an improved after-tax performance as well as reduced income tax liability.
2. What makes these funds more tax efficient and why?

The funds target sources of return that are more tax efficient than interest. In the case of SAIF the return is predominantly dividends, and in the case of SDIFOF the return is predominantly dividends and capital growth.

The dividends come from the variable rate redeemable preference shares (redeemable prefs) issued by the large banks and highly rated financial institutions. These redeemable prefs offer SAIF and SDIFOF reliable, contractual dividend cash flow. In terms of the capital growth component of SDIFOF’s return, the source is its allocation to a range of large income funds with varying but complementary strategies, providing the fund’s investors with a better risk-adjusted return.

3. What is the difference between listed and unlisted prefs?

The real question is whether the pref is redeemable or perpetual.

As the name implies, redeemable prefs are redeemable by the issuer at par value after a specified minimum period, usually three years, though these redeemable prefs can be rolled. The benefit of these instruments is that the capital price is stable, and the dividend cash flow is contractual, making it a reliable and predictable source of dividends without exposing the investor to capital price volatility. Given the minimum investment sizes these redeemable prefs are generally acquired by institutional investors.

By comparison, perpetual preference shares do not have a stated maturity date, and there is no obligation by the issuer to redeem. These perpetual prefs are generally fixed rate, more actively traded open market, and as such are subject to price volatility.

4. Shouldn’t just invest directly in redeemable prefs?

Unlisted redeemable preference shares (prefs) are not normally readily available and are issued in large tranches of around R100 million to R300 million each with issuers preferring institutional investors to retail investors. Furthermore, redeemable prefs have a minimum term to redemption of three years. A shorter term would result in the dividend being taxed at full income tax rates, effectively locking the investor in.

SAIF and SDIFoF provide the following benefits over direct investment in unlisted redeemable prefs:
• Liquidity
• Issuer diversification
• Lower minimum investment amounts
• Access to the asset class

5. Why do all the redeemable prefs have a minimum term to redemption of three years?

Legislation determines that if the holder of a redeemable preference share has the right to redemption within three years from the date of issue, the dividend from that pref will be taxed at full Income Tax rates instead of at the lower Dividends Tax rate.

Therefore, a minimum three-year term to redemption ensures the dividend income can be earned at tax efficient rates.

6. If redeemable prefs typically have a minimum three-year term to redemption, how do you manage liquidity in SAIF

Since the launch of SAIF in 2007, the fund has experienced steady growth with new pref issuance taken up evenly throughout the period. As a result, a large portion of the prefs in the fund has been in issue for longer than three years and can be redeemed within notice periods ranging between seven days and 90 days.

The fund has assets under management of over R7 billion with a diverse investor base. The fund also has various liquidity arrangements in place to manage liquidity effectively.

7. What stops me from setting up my own “SAIF”?

There are various limitations that could make the launch of a new fund, investing directly in redeemable prefs, very difficult.

  • Liquidity: When setting up a fund like SAIF, all redeemable prefs in the fund will initially have a minimum three-year term. This term places huge liquidity constraints on any redemption and effectively prevents the manager from providing 24-hour liquidity to investors.
  • Diversification and compliance: Board Notice 90 of the Collective Investment Schemes Control Act of 2002 restricts counterparty exposure to 30% per single counterparty. For a new fund, this means that multiple issuers would have to come to the market simultaneously and the chances of that happening are highly unlikely.
  • After-tax return: Pref shares are normally issued in tranches of R100 to R300 million. A new fund would need to build up large cash reserves to take up issuance, which in turn would dilute the fund’s after-tax returns as the interest portion included in the total return will rise.

However, it is possible to set up a fund of funds using SAIF as a building block.

8. How quickly do redeemable prefs, and therefore these funds themselves, react to interest rate hikes?

The standard redeemable pref has a variable return, linked to either Prime or JIBAR. None of our prefs have fixed rates.

9. What fees do the funds charge and are these fees paid from investors’ capital?

SAIF and SDIFoF have no initial or performance fees, only annual management fees. The returns that we circulate are net of annual management fees and are deducted from investors’ monthly income distributions, not from capital.

10. How do you calculate the after-tax returns for these funds?

The total returns of the funds are broken down into the different components (before tax is taken into account). These components are dividends, interest, and capital growth. The after-tax returns are calculated for both individuals and companies by deducting the following tax rates from the total returns: