Income Funds: crucial, but only part of a diversified Investment Strategy

Income Funds: crucial, but only part of a diversified Investment Strategy
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Uncertain times both locally and globally mean that South African investors are in search of stability. As a result, income funds are having a moment – let’s take a look at why that is, and whether it’s important for your own investment strategy.

First up, what is an income fund?

An income fund is defined as “a conservatively managed unit trust or exchange-traded fund (ETF) that places emphasis upon current income as opposed to capital gains”.

Generally, all income funds are conservatively managed with a sizeable allocation in low-risk instruments which serve as a buffer against market volatilities.

Do you need one?

These funds definitely play a vital role in a well-diversified investment strategy. However, as an investor it is essential that you view income strategies as just one component of your overall portfolio.

An effective investment portfolio must be:

  • Diverse,
  • tailor-made to achieve your specific objectives, time horizon and liquidity needs, and
  • designed around the tax implications relevant to your situation.

Diversification: the key to a resilient investment portfolio

Diversification is a fundamental principle of sound investment strategy, and income funds can serve as a valuable element in achieving a well-balanced and resilient portfolio. Income funds typically invest in a mix of government and corporate bonds, providing investors with a steady stream of interest income. With higher interest rates available in South Africa than many other countries, this is an attractive investment option.

South African investors often look to income funds as a means of capital preservation and regular income, especially during periods of market volatility. This can contribute to overall portfolio stability, however, don’t be tempted to rely solely on income funds. To mitigate risk and enhance long-term, inflation-beating investment returns, your portfolio should still encompass a range of asset classes, including shares (equities), bonds, property and cash.

What are the tax implications of income funds?

Income funds are interest-bearing investments and under South African tax law are subject to income tax on the interest earned within them. As an investor you need to be mindful of your tax brackets and the impact of such interest income on your overall tax liabilities.

A CERTIFIED FINANCIAL PLANNER® professional will be able to optimise the tax efficiency of your overall portfolio by housing different underlying funds in tax efficient investment vehicles, depending on the tax implications of each fund.

Offshore interest earned and tax considerations

Because the South African investment opportunities are relatively few, our investors often seek offshore exposure to diversify their portfolios and gain access to global markets. While there has been very little interest income available offshore for a number of years now, global interest rates have risen more recently, resulting in taxable offshore interest income streams again.

Roll-up funds, also known as accumulation funds, are structured to reinvest the income generated by the fund rather than distributing it to investors. By allowing the interest to compound within the fund, investors can defer tax liabilities until they eventually redeem their investment. You then only pay tax on 40% of the income (CGT). This structure can be particularly beneficial for South African investors with offshore interests.

Are people flocking to income funds?

Recent industry flows in South Africa’s money market and income funds have seen significant movements, but a record amount still remains in bank deposits despite better tax-friendly and better yield options being available at less risk.

Summing it all up

Income funds can play a valuable role in a South African investor’s portfolio, offering stability and regular income. However, it is crucial to view these funds as part of a broader, diversified strategy that considers tax implications, offshore opportunities, and overall expected inflation beating returns.

Make an appointment with your CERTIFIED FINANCIAL PLANNER® professional to consider what role income fund investments could play in your overall investment strategy, taking into account your investment horizon, risk tolerance, and long-term financial goals.


By Cameron McCallum, CFP® CA(SA)