Boosting retirement outomes in a low-return environment

It has been well documented that the average retiree has not saved enough to maintain his/her lifestyle after retirement, and many will exhaust their funds altogether.

A very real concern facing trustees is that of members’ retirement outcomes not being achieved. Ensuring members have accumulated enough for retirement and that they have a basic standard of living and sustainable income for life after they retire, is a major focus area for industry and pension funds alike. A key question for trustees, therefore, is what can be done to enhance investment returns that will benefit active members to afford them the best chance of success in retirement?

Says Cora Fernandez, Chief Executive for the Institutional Business at Sanlam Investments, “Investing too conservatively before retirement can be dangerous to your members’ financial well-being. 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?”

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

Says Fernandez, ‘In this dual context of a low-return environment and increased life expectancy, to ensure the best possible retirement outcomes, 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 long enough 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”.

Investing smartly before retirement: 4 ways to maximise retirement fund returns
In South Africa, we are controlled by Regulation 28 which prescribes the maximum limits for retirement funds to invest in certain asset classes, ie, 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.

There are a number of levers to increase returns in retirement portfolios within the limits of Regulation 28, and trustees could consider the following:

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

Source: Inet, December 2014

The graph (above) illustrates that over the long term, equities (growth assets) have outperformed cash and bonds (income assets) significantly. In the short term, stock markets experience sharp movements and 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 5 years) are generally associated with greater volatility and risk of capital losses. As the investment time horizon increases (5 years+), however, the volatility of returns and the probability of losses reduces dramatically. In other words, the longer you remain invested, the lower the risk of losing your invested capital. We believe that the unpredictability and short-term volatility of the markets is perfectly normal, and as we have seen from the past 5 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 like equity, bonds and cash. Hedge funds are designed to reduce market volatility for investors by applying specialist strategies and should be considered as one of the building blocks of a well-diversified investment portfolio.

3. Add more property
There is no maximum on the combined exposure of equity and property, meaning 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 – above all, ensuring the best possible retirement outcomes for your pension fund members and enabling them to save enough for retirement. Ultimately, however, for members and trustees alike, they all share one primary risk: 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.

Disclaimer

Sanlam Investment Management (Pty) Ltd (“SIM”) is an authorised Financial Services Provider. This publication is intended for information purposes only and the information in it does not constitute financial advice as contemplated in terms of the Financial Advisory and Intermediary Services Act. Although all reasonable steps have been taken to ensure the information in this document is accurate, SIM does not accept any responsibility for any claim, damages, loss or expense, however it arises, out of or in connection with the information in this document. Please note that past performances are not necessarily an accurate determination of future performances and the performance of a fund depends on the underlying assets and variable market factors. International investments or investments in foreign securities could be accompanied by additional risks, such as potential constraints on liquidity and the repatriation of funds, macroeconomic risk, political risk, foreign exchange risk, tax risk and settlement risk, as well as potential limitations on the availability of market information. Independent professional financial advice should always be sought before making an investment decision.