December 11, 2020

One lesson from 2020

By Marcus Rautenbach, Principal Investment Consultant

The COVID-19 pandemic and associate measures resulted in the harshest contraction in the prices of financial assets in the shortest time to date, and the fastest recovery in the prices of financial assets to date.

What have we learnt from our experience in 2020?

The construction of the default investment strategies used by retirement funds makes sense

  • The default lifestage investment strategies invest the savings of younger retirement fund members in growth portfolios with greater exposure to risky assets. The aim is to achieve higher growth over the long term. These portfolios were affected harshly by the downturn in prices of financial assets, but also recovered most during the recovery phase that followed.
  • Conservative or guaranteed portfolios, in which the savings of those members closer to retirement are invested, were less affected by the downturn in prices of financial assets. These portfolios continued to provide members with a stable platform from which to plan for their retirement.

Dips in investment returns not uncommon

Retirement savings are invested in risky assets to secure sufficient long-term growth.

One should expect occasional periods of poor investment returns when the prices of financial assets go down. Graph 1 shows that the rolling 12-month investment return of a balanced Regulation 28 compliant composite index has dipped below zero on seven occasions since 1987 (representing 41 out of 393 data points).

Graph 1

We experienced one such downturn recently, in 2020.

Required rate of return

The industry often advocates a required rate of return for retirement savers, of 5.5% p.a. above inflation after fees (e.g. 0.75% p.a.).

The average inflation rate that prevailed in the period was 7.7% p.a. The nominal required rate of return on retirement savings for the period is therefore 13.95% p.a. (allowing 0.75% p.a. for fees).

The actual compounded and annualised investment return for the Regulation 28 compliant composite index from 1987 to August 2020 is 14.8% p.a.

A passive strategy, with monthly rebalancing, would have achieved the required rate of return over the period.

The standard deviation (risk) of the return time series is 11.9% p.a.

Lower volatility and higher returns don’t always go hand in hand

The volatility or risk of the composite index has spiked significantly in 2020 (refer to graph 2), similar to the emerging market currency crisis in 1998 and the Global Financial Crisis in 2008.

However, in the period from 2011 to February 2020, financial markets experienced nine years of subdued volatility. It is not clear whether the volatility will revert to the subdued levels experienced between 2011 and 2019, or will remain at an elevated level.

Interestingly, the lower volatility in the prices of financial assets does not necessarily result in higher investment returns. Even though volatility remained subdued in the period from 2011 to 2019 (graph 2), investment returns trended lower over the same period (graph 1).

Graph 2

Frequency of downturns

The distress experienced during a downturn in the prices of financial assets is reflected in both the duration of the downturn and how sharply prices drop during the downturn. From 1987 to date, we have experienced seven downturns that lasted eight months or longer (table 1).

Table 1

Month-end before downturn commenced Duration of downturn (months) Maximum drawdown (%)
Oct-87 15 -17.8%
Apr-98 11 -25.0%
May-02 18 -21.7%
May-08 22 -27.9%
May-16 10 -4.7%
Nov-17 8 -5.8%
Jan-20 8 -18.3%


When combining the impact of the duration of the downturn and the maximum drawdown, it appears that the financial distress experienced during the COVID-19 pandemic was less severe than during the Global Financial Crisis in 2008, the 2002 bear market, the 1998 emerging market currency crisis and the 1987 contraction.

South Africa has experienced three downturns in the prices of financial assets in the past five years. Even when combining the 2016 and 2017 downturns (both downturns were modest, with the 2017 downturn following shortly on the 2016 downturn), dealing with two downturns in five years remains challenging.

The data shows that one could expect a significant downturn in the prices of financial assets once every 9½ years. However, this does not suggest that such downturns would occur 9½ years apart. A similar calculation in 2008 suggested that a significant downturn could occur once every 11 years.

The subdued volatility of the composite index in the period from 2011 to 2019 (graph 2) suggests a lower risk environment, but the three downturns experienced since 2016 show that risky events occur more frequently.

Asset allocation for growth portfolios – static vs flexible

The risk and return data to date still supports the use of portfolios that rely on a long-term liability-driven static asset allocation that rewards specialist investment mandates for individuals asset classes based on best-of-breed principles (“specialist construct”). Table 2 shows the average asset allocation maintained by these portfolios on 30 June 2020.

Table 2

Average asset allocation of multi-manager growth funds using a specialist construct – June 2020 % of Total
SA Shares 42.8%
Listed property 4.8%
Money market 1.7%
Bonds 16.7%
Other 3.8%
Offshore Shares 28.1%
Bonds, money market & property 1.8%
Other 0.4%
Total 100.0%
Total shares 71.8%
Total offshore 30.9%

(Average includes Momentum Enhanced Factor 7, Old Mutual m|m Inflation Plus 5-7%, Sanlam Accumulation, SMM70, Sygnia Signature 70.)

The more frequent occurrence of events of significant risk rewards funds that combine two or more balanced portfolios that are allowed to include tactical asset allocation shifts (within pre-determined guidelines) in addition to making security selection decisions and engaging in value-added activities (balanced construct). Table 3 shows the average asset allocation of these portfolios.

Table 3

Average asset allocation of growth funds using a balanced construct – June 2020 % of Total for multi-managers % of Total for top 10 funds
SA Shares 42.3% 39.0%
Listed property 2.1% 2.3%
Money market 4.4% 7.0%
Bonds 18.5% 19.6%
Other 3.0% 2.4%
Offshore Shares 25.3% 25.5%
Bonds, money market & property 4.2% 3.5%
Other 0.1% 0.8%
Total 100.0% 100.0%
Total shares 64.9% 67.6%
Total offshore 30.0% 29.6%

(Average for multi-manager includes Alexander Forbes Performer, Simeka Wealth Creator, Stanlib Multi Manager Balanced; average for top balanced funds includes ABSA Global Balanced, Allan Gray Global Balanced, Coronation Houseview, Foord Balanced, Ninety One Balanced, OMIG MacroSolutions Profile Balanced, PSG Balanced, Prudential Balanced, SIM Balanced, Stanlib Global Balanced)

The balanced funds where investment managers employ tactical asset allocation shifts (table 3) maintain lower exposure to both domestic and offshore equity, lower exposure to domestic listed property and higher exposure to both domestic and offshore interest-bearing assets than funds that adhere to a static asset allocation (table 2).

Which works best for growth portfolios – static or flexible asset allocation?

The benefit of successful tactical asset allocation shifts during periods of volatility should be reflected in the results of balanced portfolios. Yet, the average annual return and average annualised standard deviation for balanced construct funds and specialist construct funds for the 12-month periods starting on 1 July 2011 and ending on 30 June 2020 show that specialist construct funds perform better than balanced construct funds (table 4). The risk on balanced construct funds was lower than the risk on specialist construct funds.

Table 4

Average 12-month risk and return to June each year Risk Return
Specialist construct multi-manager funds (Table 2) 8.7% 10.9%
Balanced construct multi-manager funds (Table 3 ‘second-last column) 8.0% 10.6%
Top 10 balanced funds (Table 3 last column) 8.0% 10.3%


However, the risk and return plots for specialist and balanced construct funds for each of the 12-month periods to June, from 1 July 2011 to 30 June 2020, show that specialist construct funds perform better than balanced construct funds in periods when high investment returns are achieved in trending markets (e.g. 2012 to 2015). Balanced construct funds perform better than specialist construct funds in the periods of significant risk identified in table 1 (e.g. 2016 to 2020).

Graph 3

A lesson learnt from 2020

A lesson learnt from 2020 is that the specialist construct funds used in the growth phases of default lifestage investment strategies are likely to perform better than comparable balanced construct funds over the long term.

The lesson continues in that the lower risk balanced construct funds could be considered in periods of continued low returns that are interspersed with significant downturns (risk events); or for those seeking lower risk exposure.

It seems that investment managers who can increase or decrease exposure to attractive or less attractive asset classes are not necessarily able to deliver better returns, but that they are better able to navigate the challenges posed by the more frequent occurrence of significant risk events.

One can conclude from the information above that retirement savers who are able to look past the impact of shorter-term volatility may be better served to remain invested in the default lifestage growth phase portfolios that often employ a specialist construct while those who are more concerned about risk may wish to consider investing their savings in lifestage growth phase portfolios that employ a balanced construct.

It is heartening is note that the approach used to build our default investment strategies still applies despite of how the recent COVID contraction affected our retirement savings.