Edition: June - August 2015
EXPERT OPINION

How to boost retirement outcomes

There are four basic ways to do it, advises Cora Fernandez, chief executive for institutional business at Sanlam Investments.

Hunter Fernandez . . . maximise equities

A real concern for trustees is that the desired retirement outcomes for their fund’s members aren’t achieved. To ensure that members have accumulated sufficient savings for retirement, and that they have a basic standard of living and sustainable income for life after they retire, are major focus areas for pension funds and their service providers. The overarching question is what trustees can do to enhance investment returns that will benefit active members so as to afford them the best chance of success in retirement.

Investing too conservatively before retirement can be dangerous to fund members’ financial wellbeing. As trustees and principal officers, are you confident that the pension-plan options you provide for your members will help towards achieving the best possible retirement outcomes? Are you providing aggressive enough growth-investment options for younger members with longer time horizons?

A most significant trend across the globe is the continuing increase in human longevity due mainly to ongoing improvements in nutrition, public health and medical technology. Add to this the reality of an expected low-return investment environment – coupled with a trend of lower interest rates for an extended time period – and many individuals could find themselves at the mercy of poor returns from their retirement savings.

In this dual context of a low-return environment and increased life expectancy, it’s all the more challenging to ensure the best possible retirement outcomes. To achieve them, we believe that it is better to maximise the equity allocations in your pension fund for the best inflation-beating returns over the long term. Provided your members have a sufficiently long investment horizon, equities still yield the best possible returns over the long term.

“To ensure the higher longer-term capital growth necessary to outpace inflation, sufficient exposure to equities and other growth assets in a retirement fund is essential”.

Four ways to invest smartly before retirement In South Africa, we are governed by Regulation 28 of the Pension Funds Act. It prescribes the maximum limits for retirement funds to invest in certain asset classes i.e. no more than 75% in equities (local & offshore); 25% in property (local & offshore); 25% in international assets (excluding African investments); 15% in hedge funds and private equity combined (10% maximum for each of these) and 5% in African investments outside SA.

There are a number of levers to increase returns in retirement portfolios within the limits of Reg 28. Trustees could consider the following:

1. Use the full 75% equity allocation
We believe it is important to maximize the full 75% allocation to equities, to ensure the best possible returns, provided your members have a sufficiently long investment horizon to stomach volatility. Over the long term, a higher allocation to equities can enhance portfolio returns considerably.

The graph illustrates that, over the long term, equities (growth assets) have significantly outperformed cash and bonds (income assets). In the short term, stock markets experience sharp movements. It is this volatility that discourages many members and trustees from investing in equities. In the long run, however, no other asset class produces comparable returns.

Historically we have seen that shorter investment time horizons (up to five years) are generally associated with greater volatility and risk of capital losses. As the investment time horizon increases (five years-plus), however, the volatility of returns and the probability of losses reduce dramatically. In other words, the longer you remain invested, the lower the risk of losing your invested capital. The unpredictability and short-term volatility of the markets is perfectly normal. As we have seen from the past five decades, equities reward investors over the long term.

2. Add alternative and other investment allocations
Alternative investments -- specifically fund of hedge funds and fund of private equity funds -- offer relatively uncorrelated returns in comparison to traditional asset classes such as equities, bonds and cash. Hedge funds are designed to reduce market volatility for investors by applying specialist strategies and should be considered as a building block in a welldiversified investment portfolio.

3. Add more property
There is no regulated maximum on the combined exposure of equities and property. So these two asset classes combined could theoretically take up the entire portfolio.

4. Use the Africa allocation
Additional geographic diversification is allowed through Africa exposure of up to 5% in addition to the 25% exposure to international assets generically. Total foreign exposure can therefore reach 30%.

Conclusion:
As trustees, you have challenging goals. Priorities are to ensure the best possible retirement outcomes for your pension-fund members and enabling them to save enough for retirement. Ultimately, members and trustees share the primary risk of failing to meet their retirement objectives. In attempting to resolve this problem, we have focused on investing wisely before retirement – selecting equities and other growth assets as an effective, long-term, pre-retirement investment strategy.

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