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Capital
Protected Offshore Investments for Gratuity Contributions
(8/5/2006)
Throughout the
Middle East, new rules have meant that all companies now have to physically set aside money for their employees Gratuity entitlement. Most companies have elected to leave this money in bank accounts where it is safe and instantly accessible.
However, with regional business accounts rarely offering interest rates of more than 2% and inflation well over 15%, this money is not even retaining its’ value let alone producing any reasonable return. So what can be done to make this money work harder?
There are several restrictions on how the money can be used. Firstly, the company will need to keep a degree of liquidity so they can pay employees as and when they leave the company. Secondly, the employees’ gratuity entitlement is a fixed amount regardless of stock market conditions so the gratuity contributions should only be invested in products that have capital guarantees in place.
So how do we overcome these restrictions?
It is highly unlikely that all the employees are going to leave the company at the same time. Indeed, in most organizations the turnover of staff is well below 15% in any one year. As such, even in the worst case scenario, a company should be able to lock away between 50% and 60% of gratuity contributions. Leaving between 40% and 50% in cash deposits provides an employer with more than sufficient liquidity to cover a mass exodus of staff.
The cash deposits offer an obvious capital guarantee for that proportion of gratuity contributions but very low growth rates. For the remaining contributions, Candour Consultancy use a range of capital guaranteed offshore investments.
For most of the companies we consult, we invest in two capital protected funds; one where the capital is guaranteed to be returned after 5 years, the other where the capital is guaranteed to be returned after 10 years. The 5 year fund provides more liquidity than the 10 year fund but, because more of the money is being used to purchase the capital guarantee, the returns are slightly less.
In an average case, we would may place 50% of the gratuity contributions in a bank account earning 2% per annum, 30% of the contributions in a 5 year fund earning between 5% and 7.5% per annum and the remainder in a 10 year fund producing returns in the region of 6% to 9% per annum.
Every year, we then purchase a new 5 year fund and a new 10 year fund with that year’s gratuity entitlement and from the 5th anniversary there will be at least one fund maturing every year which aides liquidity even further. For the whole portfolio, this would produce a net return in the region of 5% per annum (as opposed to 2% in a bank account) without any adverse effect on liquidity or compromising capital protection.
Some companies may wish to offer this additional growth to employees as a (discretionary) additional bonus when they leave the company. Other companies may use the growth to pay for the employees’ medical insurance – which will become compulsory in the near future – and therefore reducing the companies expenditure.
However, another interesting option that is often overlooked by companies is that a gratuity fund could become ‘self-funding’. If the fund returns 5% a year on average, in a very short period of time, the growth produced by the portfolio of funds in any one year will be sufficient to cover that years gratuity contributions. This reduces the company’s expenditure and frees up profit for internal investment and further development of the company.
For further information on how best to structure your company’s gratuity contributions or details of the funds we regularly place gratuity contributions into, just click the ‘contact us’ button below, type GRAT FUNDS in the subject line and submit with your preferred contact details.
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