Issue: June/August 2008
Market volatility is always an issue of concern, especially for trustees of defined contribution funds. Guest columnist Scott Harvey, head of STANLIB’s Institutional Service Department*, considers some challenges and quirks in our current situation . . .
Harvey... prudential protection
Pension fund members can be forgiven for some confusion as investment
volatility mounts. It suggests that trustees may have to field an increasing
number of questions about investment performance from members worried about
This is understandable as most members obtain their information from the mass
media and stock markets only make the front pages or the seven o’clock news
bulletins when records are broken or equities slide dramatically.
Some members may be aware the JSE hit a record 31 728 points in October last
year, only to tumble in November and December, compounded by further falls in
January to around 25 000 points – a decline of 24%.By mid-April, they would have
been reassured by headlines proclaiming a new JSE record above 32 000 points.
They would conclude that equities surged in the third quarter of 2007 and
then retreated, but that all the lost ground has been recovered and equity
investments are once again doing just fine – which should mean another strong
showing by fund investments.
Members might then be perplexed by news that even some top-quartile
investment managers were reporting lower returns – often negative for March, for
the first quarter of 2008 and for the year to date.
There appears to be a mismatch between some current perceptions and current
reality. What’s going on?
At least two issues have to be communicated:
- The special nature of our equity market;
- The mix of assets found within the balanced funds into which much of the
retirement-industry wealth is channelled.
Boards of trustees that explain these factors as part of their ongoing
communication effort have a considerable advantage over boards that only
provide an explanation when volatility sets in and questions are raised.
good news is that technical terminology is unnecessary. It is quite simple
to point out that the JSE is unique among stock exchanges in relatively
diversified markets for its high concentration of resource counters.
companies account for about half of JSE capitalisation. Yet the retail and
service sector accounts for 70% of the South African economy.
have had an extremely good run on the back of continued high demand for
commodities. Last year, the sector was up 31.43%. Other sectors did not fare
nearly so well. Financials, for one, were down 16.28% for the year.
and mining companies operate in a notoriously volatile environment. When
things are going well, gains are impressive. When the sector turns or there
are safety and operational issues, significant losses can be made.
deciding asset allocations, it is highly unlikely that any prudent fund
manager would commit half of any portfolio to resources. Volatility is just
too great. Yet a 50% weighting would be in line with the JSE All Share Index
Prudent domestic equity allocations would include a more
representative spread across other sectors of the economy.
This brings us to
questions of ‘balance’ and ‘prudence’ (specifically, the application of
prudential investment guidelines as set out in Regulation 28 of the Pension
Funds Act) and the creation of balanced funds.
Regulation 28 guides
investment managers who run segregated multi-asset portfolios of pension
fund moneys, or who operate unit trust funds that mimic the prudential
characteristics of pension fund investments.
The STANLIB Stability Fund is a
good example of this type of product. In 2007 it showed a one-year return of
28.21%, placing it first in the Alexander Forbes Global Best Investment View
These asset-allocation funds are designed to achieve a balanced mix
of security, regular returns and long-term capital growth.
their holdings across various asset classes. For example, the STANLIB
Stability Fund has exposure to seven different asset classes (domestic
equities, bonds, listed property and cash, as well as foreign equities,
bonds and cash).
The Fund is characterised as a medium-equity product.
Therefore the overall equity commitment will be limited, while within the
equity category a judicious spread of counters will be evident rather than
one massive ‘bet’ on highly volatile resource counters.
Factors such as these
indicate that no prudent pension fund portfolio can possibly secure full
exposure to the JSE’s biggest current winner, namely resources.
performance therefore will be at somewhat lower levels.
Does this mean that
balanced portfolios are doomed to sub-optimal returns for the sake of
security? Not if a long view is taken.
Analysts track the relative
performance of global balanced funds representing the best investment view
in their category. Their returns are compared with the major indices.
would expect of balanced mandates, they are never top, but neither are they
at the bottom. On the whole, pension fund members can expect a creditable showing.
In 2003, balanced funds were third from eight indices. In 2004, were
up to second. In 2005, 2006 and 2007 they were once again third in the
In summary, prudential multi-asset portfolios admittedly fail to
reflect all the stellar gains recently made in the volatile resource
category, and some short-term negative results have been witnessed. But
prudential funds continue to do well over the longer term while cushioning
much of the volatility. On balance, that’s a significant plus.
Institutional Service is a division of STANLIB, a leading institutional
asset manager and domestic unit trust company of the year for 2007.