Issue: December 2011 / February 2012
Editorials

FINANCIAL CRISIS

Lower those expectations

The tectonic plates have shifted. Lower economic growth means lower equity markets, which means lower returns on retirement savings. The long term could be long indeed.

Let’s not bother with who’s to blame. Let’s rather bother with the prospect, more likely the probability, of flat equity markets continuing for as far as the eye can see. And then some.

There’s enough in it to bother even those few, perilously few, South Africans who’d thought they’d been saving comfortably for their retirements. As developed economies move in lockstep, setting the globalisation trends afflicting SA by the contagion now spreading from the eurozone, only by a smidgen might the JSE be expected to defy the fate of major indices that have been crawling on their bellies (see graph).

By and large, over the past decade or so SA pension funds have become accustomed to buoyant returns on their equity portfolios. There’ve been blips and downward rushes, of course, like the bursting of the internet bubble in the early 2000s and the post-Lehman crash of 2008.

But see how the markets have recovered. It goes to show – doesn’t it? -- that all the canny investor need do is hang in until “normality” returns. Merely look at the historical patterns of share-price performance and sleep easy.

Or not so easy, because the latest sovereign-debt crisis is unlike any previously overcome. What’s described in polite circles as “volatility” is the new normality. Turmoil has become more extreme and bubble-bursting more frequent. If there isn’t to be a double-dip recession, there’ll at best be weak growth. Asset managers’ achievements will inexorably fall short of pension funds’ aspirations.

Financial advisors too should start sharpening their pencils, and clients start lowering their expectations. No longer can they rely on the generous 10%-plus average returns with which they’ve been rewarded over the bumper decade now gone. They’re caught in the double-whammy of rising inflation and reduced income from savings. 

This means two things.

First, pensioners will be hit. The drawdowns on their living annuities, for example, will deplete. Either they’ll have to dig deeper into capital, causing their money to run out sooner, or they’ll have to adjust their living standards from a base that for many is already a shadow of their working-life experience.

Job prospects for even the fit and healthy of the post-World War II baby-boom generation aren’t bright. Their alternative, unless they have wealthy children willing to support them, is to embark on lifestyle regimens intended to shorten their longevity. An inability to afford remorselessly-increasing medical costs can do it for them.

Second, pensioners-to-be had better relook the rates at which they contribute to their retirement funds. The conventional rule-of-thumb was that contributing say 12% of salary over a 40-year working life would see the retiree home and dry to a secure nett replacement ratio of around 75%-80% (the proportion of pre-retirement salary in a pension).

But this is pie in the sky anyway, not least because of the alarmingly low propensity to preserve retirement savings on switching jobs. Moreover, it assumed that historic returns would hold.

Compared with bourses in developed countries, the JSE has been remarkably fortunate. For all the hype about equity recoveries and consistency of long-term growth, in October the S&P 500 (the world’s most widely-tracked index) was back to where it had closed three years earlier. So too with the FTSE all-world index.

The most exciting years in financial history have gone nowhere. Taking a longer period, the Dow Jones industrial average has done no better in 12 years than criss-cross the 11 000 mark.

Investments’ tectonic plates have shifted. Faith in the asset class most proven to produce inflation-beating returns has been shaken.

Just as well that SA is one of the Brics. They’re still in favour, and long may they continue to be. As world growth enters a period of protracted slowdown, however, it’s not an assumption on which to base prudent retirement planning.