Timidity can cost more than risk
A tough 10 years for pension investors
Your long-term investments probably need a high exposure to equities - but most South African retirement fund members are too conservatively invested, which means they risk having too little money when they reach retirement age.
South Africans are generally so preoccupied by the volatility of returns that they don't expose themselves to enough investment risk. In so doing they ignore the biggest risk of all: being underfunded when they reach the end of their investment term, says Brandon Zietsman, CEO of Portfoliometrix, which provides investment services to financial advisers.
Paul Stewart, the head of fund management at Bridge Fund Managers, says retirement fund members and retirees funding a pension from their investments use balanced or multi-asset funds to deliver the returns they need. But many fund managers have been too cautious over the past decade, and the returns have been below what is needed.
Now, he says, after a decade of low returns, investors are in distress with their financial plans, and asking searching questions about their retirement.
Retirement plans are based on you achieving an after-inflation return of 5% after costs. However, Stewart says, many balanced or multi-asset funds in which pensioners invest have underperformed this target by as much as 3% a year. And they have lost another 1% to fees over the past 10 years to the end of July.
The returns on three of the four asset classes typically included in retirement investments delivered below CPI plus 5%.
So money invested in shares delivered CPI plus 4.1%, bonds CPI plus 2.5% and cash CPI plus 1.2%. Only South African listed property - the fourth asset class - delivered returns of 7.7% above inflation before costs had been deducted, Stewart says.
If you had a good active fund manager delivering consistent returns 1% to 2% above the market, you would probably have only earned a nominal return of 12% over the past 10 years - or at best 11% after costs.
He says this is too low for the target most investors need and shows that asset managers have been too conservative.
More exposure to shares and property and less to cash and bonds would have produced significantly better results for investors over the decade, Stewart says.
Graham Tucker, portfolio manager at Old Mutual Investment Group's MacroSolutions boutique, says balanced funds have generally been a good way to grow your real (after-inflation) wealth, while managing the volatility to a level you can accept.
However, the past decade has been a particularly challenging period for riskier assets, and therefore for balanced funds, Tucker says.
The decade includes the global financial crisis and, more recently, the soft patch in local equities, a key asset class in balanced funds. The returns over the past seven years - after the worst of the 2008 financial crisis - are much healthier, he says.
What a conservative stance can cost you
Investing in a fund that has only 30% to 40% in equities may feel a lot safer than investing in one that has 75%, but the danger is underfunding your retirement or any other long-term investment goal, says Tracy Jensen, the chief product architect at 10X Investments.
She says long-term data shows that a fund or portfolio with 30% in equities has on average delivered a return two percentage points lower than one with 55% in equities. An exposure of 75% of the fund or portfolio to equities has, on average, delivered 1.5 percentage points more than one with 55% in equities.
Even if you have only 10 years to go to retirement, you are still a long-term investor, and you should have 75% of your retirement savings in shares and listed property as you have time to ride out the ups and downs of the market.
Jensen says retirement fund members who are in balanced funds offered by the bigger asset managers tend to have 60% to 75% in equities, but those saving in life assurance companies' funds, where the default investment is a smoothed bonus or guaranteed product, have higher fees and lower exposure to equities.
Zietsman says you should beware of the use of actual data to prove a case. All you can be sure of is that investment returns over the next decade will not be the same as those of the past one.
He cautions against overweighting an asset class such as listed property, as its fortunes are linked to those of the economy.
Fund managers often invest too cautiously because they are trying to avoid volatility: many investors sell off their assets or switch managers when the value of their investments drop, Stewart says.
But workers and pensioners need to take risks if they are to ensure they have an income for what may be a long period of retirement. This risk will come with volatility, which may include sustained periods of low or negative returns.
But, Stewart says, investors need to realise that price volatility is not a permanent loss of capital - you will probably make money in the long term.
Zietsman says many investors lose their composure when returns fall. This is where good advisers, who coachyou on what to expect and prevent you from disinvesting at the wrong time, earn their fees.
When you are saving for retirement, risk is your friend, and when a market falls, it provides an opportunity for you to buy more on that market, Zietsman says.
The real problem, says Tucker, is not whether balanced funds are delivering returns slightly above or below the targeted return, but whether you have the right level of exposure to growth assets.
Investors often prefer the safety of cash, because of a perceived risk or possible events if they buy shares, but for most investors this decision does far more damage to their wealth. Says Tucker: "Over the long term, cash is an exceptionally poor investment in that it simply does not deliver the real returns you will require."
Zietsman says the biggest mistake people make is to de-risk too much before their retirement. This is especially true if they sign up for an investment-linked living annuity, and potentially have to earn an income for another 30 years.
If you are worried about the rand and your investments in South Africa, remember that local balanced funds have two "insurance policies". First, a large part of their 25% offshore allowance is invested in foreign markets, and, second, when the currency weakens, the price of many local shares benefit from offshore earnings.