Issue: December 08/February 09
Editorials

COVER STORY

Bottoms up!

Top consultants to retirement funds share the advice they’re giving their clients. There’s a remarkable consensus: Hang in and exploit the fantastic buying opportunities that present themselves.

Trustees of retirement funds are nervous as hell. Understandably so. Through October, which was particularly disastrous for JSE and world share prices, and into November, when glimmers of relief began to show, one hard question has permeated every trustee discussion: “What do we do now?”

Do they reduce their fund’s exposure to equities? Do they switch more into cash and fixed-interest securities? Do they withdraw from offshore holdings? Do they seek out the rand hedges? Do they take a chance on financials? Do they pull back on commodities and resources? Do they sit tight, in the hope that the nightmare will soon pass, or do they seek bargains, in anticipation that what’s cheap today might be a little cheaper tomorrow but will be more expensive in coming months?

We asked a cross-section of prominent fund consultants to put their views on the line. Here’s what they said.

Jarred Glansbeek

Glansbeek . . . value is showing

Jarred Glansbeek, RisCura:

Fund portfolios would already have sustained most of the losses. While there is still the prospect of markets dropping further, we believe this potential is slowing and value is starting to show. At this point, funds should be buying assets rather than realising losses. We also suspect that an anticipated poor company report-back season may well put a hold on the market recovery for the next while, extending the buying opportunity.

On the positive side, foreign asset values go up when the rand depreciates. Despite the 30% fall in markets since the beginning of 2007, the rand has depreciated by more than 35% over the same period. This has contained losses over the period to 10%-20% on a SA fund’s offshore equity component.

Foreign market turmoil has negatively affected SA share prices. SA’s problem is less about our banks, which have mostly been protected from the credit crunch, and more about resource/commodity shares that are being punished in light of a global recession. Most of the resource-sector gains over the past eight years, relative to financial and industrial shares, have been wiped off the scorecard in the past few months.

On the whole, SA shares have become very cheap. They are at valuation levels last seen in 1998 and 2003. Both these times presented unbelievable investment opportunities, and markets went on to perform very well. This certainly was why SA retirement funds did so well until just over a year ago. While performance from these levels may take a little longer, again markets are so cheap that selling at these levels and moving assets into cash, even though markets may continue to fall on the back of company-earnings disappointments, would be a poor decision.

Yes, markets have been a tough place for investors and retirement funds, but funds with sound strategies should outperform their benchmarks over this period. In addition, funds are structured to reflect a diversification of managers and products in a variety of countries, asset classes and assets, all which serve to protect a fund’s overall objectives.

This is small comfort as asset values have certainly been hurt in the turmoil. Markets are extremely cheap as investors are panic selling at what may be fire-sale prices. Now is certainly not the time for funds to sell assets, but rather to look for well-timed opportunities to purchase risk across different markets and asset classes.

Rowan Burger

Burger . . . communication vital

Rowan Burger, Alexander Forbes:

To a large extent, the horse has already bolted. The market may have overreacted but will continue to be hugely volatile over this period of “price discovery”. Any significant change to a fund’s strategy could be poorly timed.

Trustees of defined-contribution (DC) and definedbenefit (DB) funds may take different approaches, as would those trustees of DC funds offering members some level of investment choice.

For DC funds with member investment choice, the key would be to communicate properly with members. An analysis of members’ recent investment switches would indicate whether they were inclined to follow unit-trust investors into short-term cash strategies when long-term strategies make for a successful retirement plan. This exercise would test the effectiveness of trustees’ past education and communication strategies.

Individuals close to retirement have a more pressing need. For them, security of income rather than security of capital is important. A seamless investment approach in pre- and post-retirement periods is essential. Professional advice is critical.

For DC funds with no member investment choice, communication is equally important. Without appropriate understanding, confidence in a scheme and its trustees will be significantly eroded by reductions in benefit levels. Trustees may need to consider whether the current investment managers are able to deliver on their long-term strategy. Different approaches are required in times of bull and bear markets.

For trustees of DB plans, continued solvency of their fund becomes a major concern. It is probably opportune to consider a new asset/liability matching exercise, given reduced funding levels and changes to expected return profiles of the various asset classes.

With inflationary fears still evident, these trustees should consider “real cash-flow matching” investments. They involve matching the fund’s projected cash flows with an investment from a bank or insurance company. By investing in a “real” cash-flow match, the actual cash flows that the counterparty pays back to the fund will be increased by actual inflation.

As the fund’s obligations will then be more closely matched by its investments, the value is in the lowering of investment risk that the fund faces. Also, cashflow- matching investments currently offer yield pickups of more than 1% over the corresponding bond curve. This can lead to unlocking around 10% to 15% of a portfolio’s value, so increasing the potential return.

Rudolf Schmidt

Schmidt . . . recovery will come

Rudolf Schmidt, SEI Investments:

The fundamentals of investing are not broken. They just don’t work in a time of crisis when fear and irrationality are driving decisions. As we move through the current crisis, the fundamentals will once again recover, active management will deliver and share prices will reflect their underlying value.

Crises and cycles are part of investing. They are critical to the long-term investment strategy of every fund. The strategy that dictates and drives the strategic asset allocation should be based on the long-term risk-andreturn expectations of each fund. It should include assumptions that the markets will perform poorly from time to time.

Assumptions used by actuaries to calculate the appropriate asset allocation, based on the fund’s objectives, are usually very conservative. Therefore, in a crisis, strategy generally does not require any action from trustees.

In each of the three crises during the past 10 years, fears have been similar. The reality is that in time the cycle will turn and the crisis will be fully discounted. Markets will de-couple, fundamentals will take over and each market will recover on the strength of its own fundamentals, making active (rather than passive) management the preferred choice.

At present, there is still too much uncertainty. Selling is driven by fear and irrational behaviour. The biggest mistake trustees can make is to get caught up and sell into weakness.

Portfolios are today showing paper losses. Should trustees lose faith in their strategy or in the markets and decide to sell, these losses will be realised with little opportunity to recover. Timing is impossible as markets move quickly and without notice. By the time a board of trustees has decided to re-enter the market, the biggest part of the recovery may already be over.

Although diversification does not seem to work in the short term, it is key to navigating any crisis and ensuring funds meet their long-term investment objective. While the equity markets come to grips with the global debt/credit crisis and the imminent recession, fixed interest (bonds), property, low-volatility fund of hedge funds and cash will provide portfolios with less volatility and downside protection.

The only actions required by trustees will be to ensure they have deployed the correct investment strategy based on the profile of their members, that their chosen fund managers are sticking to their mandates, and that they continuously communicate to their member base, educating them through the crisis and ensuring they do not make bad decisions. Fund managers are continuously rotating their portfolios as they find new and better opportunities, positioning portfolios for the recovery.

So the best decision trustees can make is to do nothing.

Roland Gräbe

Gräbe . . . changes over time

Roland Gräbe, Brockhouse Cooper:

The current market can be compared to a half-price sale at your local supermarket. Stock prices reflect not only a poor earnings outlook, but also negative sentiment around equity returns for the immediate future. At times like these, astute asset managers can acquire shares in great companies at reasonable valuations. To do so, funds should:

Allow equity managers to run high-tracking error portfolios;

  • Avoid sector-neutral and style-neutral strategies;
  • Avoid over-diversification of managers;
  • Allow active asset allocation.

When more than one asset manager is used, it is vital that the consultant performs holdings-based analysis on the composite portfolio. By combining managers with different styles, good risk is often diversified away, leaving an equity portfolio with too little “alpha” potential and high average fees.

The surest way to create an underperforming strategy is to give equal allocations to a multitude of managers. Predictably, the performance they achieve will then be average. Worse, by reducing the mandate size the fee impact is maximised. The outcome for the fund is therefore inferior performance at the highest possible fee. One good manager would create a much better portfolio than five managers producing an average.

Asset managers are in the best position to make asset-allocation decisions. There are opportunities in our market to achieve better returns and to reduce risk by changing the fund’s asset allocation over time. Rather than control this process, consultants should assist pension funds to identify managers with a proven track record in achieving outperformance in this way.

Since active management requires patience, trustees should allow managers at least three years to prove their worth. Ban survey rankings from your trustee meetings, and monitor managers against fair but challenging benchmarks.

Bernard van Wyk

Van Wyk . . . just be patient

Bernard van Wyk, Absa Consultants & Actuaries

For periods longer than 10 years, the local equity market has never recorded a negative return. Fund members with a long time horizon should thus be able to tolerate the market’s present volatility.

Members close to retirement might be under the impression that they have a short time horizon and that the current market losses will adversely affect their financial wellbeing as they’d have to sell out of equities, effectively locking in their losses. Depending on how a member plans for retirement, there is no need for him to sell out of equities at retirement.

His post-retirement exposure to equity markets can be anywhere between 15 and 30 years. This is ample time for his portfolio to recuperate. Members must realise that their time horizons don’t end with retirement.

When a member does retire, he can buy a living annuity or a guaranteed annuity. The cost of a living annuity is linked to equity-market performance; as a member’s retirement assets rise and fall, so does the cost of the living annuity.

For a guaranteed annuity, the cost is linked to interest rates and not the equity market. Current market conditions do pose a threat for those members planning to purchase a guaranteed annuity at retirement and have a high exposure to equity markets; their retirement savings could have fallen without the cost of the guaranteed annuity coming down.

The local equity market has delivered phenomenal returns over the past 15 years, during which there have been times of turmoil. When the market recovered, returns have been spectacular.