Issue: December 08/February 09
Editorials

REFLECTIONS

You must have been prepared

Rob Rusconi

Rusconi... no excuse

Surely you were. That’s your financial advisers’ job, points out ROB RUSCONI.

The fašade of financial sophistication has come crashing down, leaving people feeling exposed and confused about what to do next. Over the past few weeks, many trustees must have tried valiantly to resist the urge to react emotionally.

In the markets’ dramatic fall, SA pension funds have lost significant value. Nobody can say whether we’ve reached the bottom. Worse, we cannot tell what this means for tomorrow’s market environment.

Your pension fund members are asking questions, surely? How do you respond, calmly or with a sense of panic? The answer depends on your preparedness.

A market crash nearly always feels unique. This has never happened before, not like this, we feel and hear. Some say it could be as bad as the Great Depression. We couldn’t possibly have prepared for this.

That isn’t true. Every crash is unique. Circumstances change and every downturn takes place in a different context. We hypothesise the drivers of the rapid fall but don’t really know and cannot call the bottom. Everything feels worse when we’re experiencing it than in retrospect when we can look back at it with perfect hindsight.

We have no excuse for lack of preparation. The market fall was predictable; not the date and time or the extent and nature of it, but the fact that it would happen. With complete certainty, for long-term investors, crashes happen. We should all have been ready for it. If your fund enjoys – and pays for – the services of an asset consultant, that organisation should have prepared you for this.

Those who build houses on the Gulf of Mexico do not expect a hurricane in the next week but they know they are erecting a building that needs to stand for a while and that it will experience nasty weather during that time. It is structurally strong, able to withstand strong winds and high seas. This is long-term preparation. It is compulsory for building in that part of the world.

Early every summer, prudent occupiers of houses like these check that they are sound and ready for the possibility of heavy weather in the next few months as the hurricane season looms. They repair broken roof tiles and watch for rusty window-hinges. They prepare an evacuation plan, should it come down to that. This is medium-term preparation. It forms part of prudent living on a hurricane coast.

Of course, weather is predictable, at least in the short term, and we can respond to it, but without long-term preparation we run serious risk of disaster when the storm strikes.

Daily market movements are not as easily forecast as changing weather patterns, but they are predictable in the long term. Since you are investing the assets of your members for the long term, you take into account both return potential and risk when you allocate assets to the available classes

You know that equities are expected to give good returns in the long term, because your advisers show you this. You also know that returns are characterised by volatility, because your board of trustees has been led carefully through the tricky trade-offs that lie at the heart of the asset-allocation decision, again by your advisers.

You were prepared for this crash because you knew it would happen . . . sometime. You and your board of trustees were not just told how well the markets had performed, especially over the past two years, you were reminded that good times never lasted forever.

Moreover, since the crash is predictable you were aware of how to respond to it. You knew that your so-called “absolute-return mandates” were unlikely to be strong enough to survive a crash like this, so you chose not to depend too heavily on them. You considered tactical asset allocation as a means to respond to this type of uncertainty and awarded flexible mandates to some of your asset managers, understanding nevertheless how very difficult it is to anticipate massive market changes.

By and large, though, you recognised that, as a long-term investor, you had to invest significantly in equities and that there were risks associated with such a strategy . . . and you were ready for the events that have taken place. This doesn’t make it easy, but it certainly provides the context and perspective needed to ride out the storm with confidence.

Further, you prepared your members for it. You made it clear to them why you were allocating a significant proportion of the assets to a risky strategy – because it was best in the long-term – and how you would respond to a market crash when it came around.

Finally, you might find at times like this that a fašade of human wisdom and sophistication is revealed to be a greed-influenced system of guesses. But not in the case of your service providers, let’s hope.

Rusconi consults on old age and social policy, investments and pensions, to public and private sector clients, locally and abroad. His recent discussion paper, “Institutional Investments: Whose Money is it Anyway?” is available for download at www.tresconsulting.co.za.