Time to manage RISK

Some retirement fund members may have noticed that the value of their retirement savings has not increased much over the past year. These members are worried and unsure why their savings are not growing. As the growth is not satisfactory, the questions in their minds are:

  • What has gone wrong?
  • Is my money safe?
  • Should I change my Investment Manager?

What has gone wrong?

Nothing specifically has gone wrong with most of the individual investment managers’ portfolios.

Economic and investment conditions all over the world have changed since 2015. Financial markets are struggling and will probably continue in much the same way in the short-term.

Share prices provide an example of what is happening. The FTSE/JSE All Share Index increased by 21% in 2017, but dropped by 5% over the first half of 2018.

Figure 1 : FTSE/JSE All Share Index
Figure 1 : FTSE/JSE All Share Index

To fully understand and appreciate what is happening, it is important to understand the following:

  • To grow their businesses, banks started lending out more money, sometimes to people who could not afford the repayments. Eventually, this created difficulty in the financial system, typically the sub-prime housing loan crisis in 2008.
  • The sub-prime housing loan crisis quickly became the Global Financial Crisis and an economic recession followed.
  • Central banks around the world (e.g. US Federal Reserve) managed the recession carefully by “printing more money” to stabilise the financial system.
  • This was achieved by lowering interest rates and increasing money supply in the period from 2009 to 2014.
  • With more money in the financial system, the prices of assets (e.g. share prices) increased, creating asset price inflation and a sense of prosperity.
  • As economic growth stabilised around the world, it becomes necessary to reduce money supply and repay future generations from which it had been borrowed in the first place.
  • Central banks are now raising interest rates and slowly reducing money supply by issuing government bonds.
  • Just as more money in the financial system resulted in asset prices increasing, so does a reduction in money supply lead to downward pressure on asset prices. When asset prices go down (or stays relatively flat) it leads to lower investment returns.
  • Since 2017, the approach taken by central banks are more hawkish (aggressive) than in the past. This creates even greater pressure on financial markets.
  • The US trade policy under President Trump is unfriendly to other countries. The US are taking steps to protect their trade interests at the expense of other countries. This affects the South African economy as well.
  • In South Africa, many important economic and social issues remain unresolved. Investors are adopting a wait-and-see approach to see which direction will be taken. The performance of State Owned Companies such as Eskom and SAA are of particular concern.

International markets have done better than the SA market over the last few years, but due to Regulation 28 constraints, retirement funds had limited offshore exposure.

Much of the performance on the local market is due to the performance of Naspers’ share price. Investment managers often have less exposure to Naspers than the benchmark indices do, typically because of the limits imposed by Regulation 28, but also because of the risk that accompanies high exposure to a single share, such as Naspers. Thus, the absolute performance of funds often reflects what is happening to Naspers’ share price.

Investment managers invest members’ money in (SA and offshore) shares, bonds, property and the money market. These are the “ingredients” of the members’ investment portfolios. If good quality ingredients are used, it is likely that good results will be produced; but if poor quality ingredients are used, even a good manager’s results will be very ordinary. The ingredients available to SA retirement funds are in figure 2.

Typically, members find the value shown in green pleasing (good ingredients); the values in red (poor ingredients) are associated with displeasure while the values in black are considered neither positive nor negative. It is evident that just recently, more red values started to appear in figure 2.

The impact is that the investment returns on retirement savings have been under pressure since 2015. The higher investment returns from 2009 to 2014 were perhaps the exception rather than the norm.

It is fair to draw the conclusion that the quality of ingredients available to investment managers in South Africa is not as good as it has been in the past.

Figure 2: Investment returns for asset classes in rand
Figure 2: Investment returns for asset classes in rand

Is my money safe?

For how long can the current difficult financial environment continue?

This is not clear, but for as long as central banks continue to increase interest rates (such as the Federal Reserve in the US), investment returns could continue in the same way.

It is possible that investment returns could also be volatile (e.g. up 20% in one year and down in the next year; or even up 5% in one month and down 5% in the next month). This could lead to the value of members’ savings increasing sharply, only to be followed by periods of poor performance.

Members can approach the current difficult environment in which investment returns can remain lower and more volatile in more than one way, but a well-constructed investment strategy sees one
through all kinds of markets conditions. Members who have a long-term investment time horizon should still invest in growth portfolios. Members approaching retirement age should protect their savings.

The important aspect here is to choose the risk profile that appropriately reflects each member’s investment expectations.

In normal financial market conditions, investors who assume more risk are rewarded by higher investment returns. Just recently, this relationship has not been evident as investors earned higher investment returns on cash and guaranteed smooth bonus portfolios (which are considered lower risk investments). This is illustrated in figure 3 below.

Figure 3: Risk-return profile
Figure 3: Risk-return profile

Should I change my Investment Manager?

Adverse conditions in financial markets affect most investment managers in a similar way. Growth portfolios with more exposure to shares experienced a similar slowdown in investment returns. In the same way, moderate absolute return portfolios also experienced slower investment returns, but less so than growth portfolios.

Within funds with similar risk profiles (e.g. growth, which is shown in figure 4 using the same scale as in figure 3), it is still important to select the most appropriate investment managers.
In difficult market conditions, risk tends to remain constant, but investment returns decline.

Figure 4: Risk-return parameters for large global funds (growth)
Figure 4: Risk-return parameters for large global funds (growth)

Figure 4 shows that most investment managers’ risk remained constant, while lower investment returns were earned over shorter periods. This brings one to the conclusion that it is probably not ideal to change investment managers within each of the risk profile groups at present.

To those who are concerned about the growth of their investment savings:

  • Nothing specifically has gone wrong – economic and investment conditions around the world have changed.
  • The current difficult environment could continue in the short-term.
  • Saving for retirement requires a long-term approach to investments. Members (especially members further away from retirement age) should not try to time the market or pay too much attention to short-term movements. Short-term fluctuations will be experienced at stages in financial markets.
  • Retirement fund members should make sure that their savings are invested in portfolios with risk profiles best suited to their personal requirements.
  • If members’ savings are invested in portfolios with risk profiles that satisfy their personal requirements and if there is no evident and unexplained underperformance by their selected investment manager, it is not the best time to change service providers.

At this stage, it is more important to manage risk than investment returns, and to manage the right risk at the right time.

Marcus Rautenbach
Principal Investment Consultant