Edition: Dec 2014 - Feb 2015
Context for fund members’ market expectations
Retirement fund members all fit on a continuum between two extremes – the ‘dreamer’ and the ‘market timer’ – suggests Willem le Roux, head of consulting at Simeka Consultants & Actuaries.
The dreamers pay little attention to their investments and believe that their retirement savings will continue to grow as they have done for the last number of years. The market timers try to adapt their market strategies based on information at their disposal. Members in this extreme usually read financial journals meticulously, watch news like clockwork and monitor the published unit prices of their retirement savings.
Le Roux . . . life-stage comfort
The recent performance of the equity market may lead to both dreamers and market timers making irrational decisions which could affect their investments. The dreamers may make incorrect assumptions on the future growth rate of their assets, and make retirement plans based on faulty expectations. The market timers, on the other hand, may switch their assets unduly in an attempt to "beat the market".
State of the market
SA assets have provided stellar returns since the global financial crisis in 2008. In addition, the economic recovery of the developed world has seen the global portion of our retirement savings grow exponentially over the past two years. One would have to go back many years to find a period that all domestic and foreign asset classes performed this well at the same time.
Here is a little dose of context. Real returns (returns above inflation) have been in the double-digits on an annualised basis for SA equities since the start of the year 2000. However, the long-term average return on domestic equity is closer to 7,5% above inflation.
To emphasise the point, equity markets frequently give returns far below 7,5%, such as 0,7% from 1910 until 1920 (a full decade) in order to average out at around 7,5%. The example of 0,7% for the second decade of the 1900s followed a decade of above-average returns (about 9,5% from 1900 until 1910). It is therefore possible to get very low returns from equity markets for a reasonably long time.
In terms of our legislation, the majority of SA's retirement fund assets remains invested in SA. A big driver of local returns until now has been the flow of assets from foreign investors into our stock markets (bonds and equities). However, mounting risks and market pressures may bring an end to this 'party'.
In the past, when foreign investors have left SA, they have done so in droves. This has dealt massive blows to both local investment markets and the exchange rate. Furthermore, the domestic economy is increasingly hamstrung by low growth and increasing unemployment rates, resulting in budget and current account deficits.
Local investment professionals concede that most SA investments are overpriced and don't foresee that markets will continue to perform as well as they have in the recent past. Even though markets corrected at the end of September and early in October, they have again rallied and remain expensive.
There is no way to accurately predict market returns, but it is fairly clear that there is reasonable likelihood of lower (or even negative) returns over the medium term. The message to the dreamers is that, although there has been great performance over the past decade and more, the road ahead may be rocky.
There is unfortunately no crystal ball that can help us make the perfect investment decisions. No-one can predict what the market will do. According to some professionals, SA markets were already overvalued during 2013. Yet the markets continued bolting to new record highs.
It is therefore vital that fund members consider the impact carefully when attempting to time the market. This requires withdrawing assets from risky portfolios when markets are high and then reinvesting when markets are low. This is tricky as many investment professionals get it wrong. Investment markets remain unpredictable.
The best way of making decisions on investments is to select a good strategy / philosophy and stick to it. Younger members, for instance, should have a long investment term and not worry about short-term market movements. Their biggest risk is losing out on exponential market returns as a result of a failed attempt at timing the market. Members closer to retirement should consider a gradual de-risking strategy, which ends up in a solution that protects them against their changing risks leading into retirement.
How funds assist members
To help protect both the dreamers and the market timers from making investment decisions that could lead to the destruction of value, many retirement funds offer a life-stage model as a default investment strategy. The long-term asset allocations of these portfolios are designed to provide the best possible returns given the volatility and risks inherent in investment markets.
As members approach retirement and become more vulnerable to market movements, the life-stage model systematically switches members' fund credits from aggressive to cautious portfolios. Some life-stage strategies use cash investments only in their cautious portfolios whereas others, in various degrees of efficiency, address the specific risks faced by members aiming to make use of different pension structures (annuities) in retirement.
This is crucial in order to protect the soon-to-be-pensioner against adverse market movements from various sources, such as interest rate risk (which is sorely underestimated), the risk of capital loss, inflation risk and the risk of volatility.
The life-stage model automatically personalises each member's investment strategy by investing assets in appropriate portfolios depending on the member's term to retirement. When the markets go up and down, it is comforting to know that the strategy is designed to ride the waves in the most efficient way. There is no need for either dreamers or market timers to do anything.
For retirement funds which do not offer a life-stage model and provide individual-member investment choice, communication and advice become critical not only to help temper investment expectations but also to warn against impulse switching or attempts to time the market. The safer route is to implement a life-stage solution as the default for members that do not want to make investment choices and / or do not have the requisite skill to do so.