The impact of investment style on the retirement outcomes of members

By Nomnini Mngqibisa, Associate Investment Consultant

Past performance is not an indication of future performance. The investment managers outperforming this year most likely will not appear on the list of top performing investment managers every year. However, how does this impact members choosing between investment portfolios through time? Moreover, how does a member elect to invest with a particular investment manager that will maximise their retirement outcomes? Taking it a step further, how does the assessment by a member of the investment style of a manager impact their own investment objectives and outcomes?

Members who belong to retirement funds that offer member investment choice are often faced with an intimidating list of investment portfolios to which they can have their retirement savings invested. These investment portfolios varying greatly, the impact of which could be significant on achieving members’ retirement outcomes.

An understanding of what an investment manager is seeking to achieve, what their philosophy is, how they approach their investments, and the depth of the resources that they have to analyse the assets they invest into is imperative. Of particular importance is how the blend of equity (investment style) in an investment portfolio can influence investment performance. The role of equity in an investment portfolio is to extract extra return for the added risk. All these considerations are important for members’ retirement savings.

The investment style of a manager indicates the likely asset allocation and individual securities to be selected for investment by the manager. Taking into account a manager’s investment style would also assist in evaluating the performance of an investment portfolio. Investment style may also indicate the kind of risk the manager is willing to take. Generally, investment style can refer to value, growth, momentum or quality investing. The meaning of these styles could be very confusing for the average member.

To demonstrate how investment style could impact the outcomes of a member’s retirement plan, we can, for example, look at the impact of being invested with value investment manager versus being invested in a growth investment manager. A value investor is primarily attracted by assets with low prices compared with underlying values – think of a “50% off sale” – assets are simply being sold for cheaper than they could be. Investors who use this strategy believe the market overreacts to good and bad news, resulting in price movements that do not correspond with an asset’s long-term fundamentals. On the other hand, a growth investor would typically invest in assets whose earnings are expected to grow at an above-average rate compared to the market.

While we have seen an outperformance of growth investments since 2011 compared to value investments, recent indications are that performance has turned around, leaning toward value investments. An investment manager, like Allan Gray, which had come under heavy scrutiny when value investment managers were experiencing extended under- or low performance, as has been illustrated in the below graph.

 

AG-Global-Balanced-Fund

 

Sanlam Investments have stated in that the ideal equity blend would need to have the following characteristics:

  1. Consistently outperform the benchmark; and
  2. Deliver outperformance in as smooth a manner as possible.

The ideal investment for a member would be to invest in a diversified investment strategy that is investment style neutral, which would cater for different investment experiences. An investment strategy with a long term view needs to consider the ups and downs of markets, and still be able to produce consistent returns on members’ assets. A style neutral portfolio tries to minimize style biases over short term periods as a portfolio can be hurt by any meaningful bias. It is thus important for a member to be invested through time as style neutral as possible or understand the implications thereof.

Members are often left to their own devices in choosing their investment strategy, and when they do make an investment choice, they often make their choice based on an investment manager’s brand or reputation, recent performance, investing according to irrational sentiment, or trying to time the markets. The selection of an inappropriate investment strategy can considerably reduce the ultimate retirement savings of a member. It is therefore important that investments match the investment objective of a member.

A solution for members exercising investment choice may be to have exposure to more than one investment manager. However, this would require investments knowledge, which most members of retirement funds do not have. Statistics from the 2015 Sanlam Benchmark survey indicated that only 32% of members were confident in their own investment knowledge.

Members are also prone to compounding errors, by moving assets from a low performing manager to a high performing manager (short-term performance). However, as the market moves in cycles, a member can easily be exposed to precisely the wrong managers at the wrong time. This is notoriously difficult to time correctly. The fees of switching investments need to also be measured.

In most cases, members end up invested in single manager portfolios with investment managers who have a particular investment style, which may not suit the member’s investment objectives or may significantly detract from the investment returns earned on the member’s benefit.

In line with the Financial Services Board’s Treating Customers Fairly, Boards of Trustees will need to consider that the default strategy of a retirement fund to be style neutral, and as a result should be able to earn good returns at any point in time. A good investment consultant will be able to assist you to compile a solution which is neutral in terms of bias to any style. Such solutions can also be used as member choice building blocks. Solving this problem can improve members’ retirement outcomes.

Disclaimer: This publication provides information and opinions of a general nature. It does not constitute advice and no part thereof should be relied upon without seeking appropriate professional advice.