January 17, 2022

Economic growth and retirement funds’ long-term investment returns – 17 January 2022

Long-term investment returns

One of the most important factors that contributes to a dignified retirement outcome is earning an investment return of between 5% and 6% above inflation and after fees on your retirement savings over the long term.

The long-term investment return earned by South African retirement funds may be explained by the combination of:

  (1) Domestic economic growth (GDP)
plus (2) Value added by trustees, aided by investment consultants

(capital allocation to market segments and geographies, and manager selection)

plus (3) Value added by investment managers

(capital allocation to market segments and geographies, and security selection)

plus (4) Value added by individual securities

(capital allocation by management of corporates to individual projects and operations)

minus (5) Fees, costs and levies

Source: Simeka Consultants & Actuaries

In the short term, supply/demand of securities and exogenous factors such as sentiment and currency fluctuations may distort the equation that explains investment returns.

The graph that follows partly illustrates the relationship between (1) long-term domestic GDP growth and (2) a typical retirement fund benchmark return. Positive contributions by (3) asset managers and (4) individual securities will serve to further enhance investment returns and confirm the equation above (aggregate data for (3) and (4) is not readily or publicly available).

Domestic economic growth (e.g. the growth experienced from 2000 to 2007) drives returns for everyone – even those who are not as smart at capital allocation. Healthy economic growth and good capital allocation decisions by trustees, asset managers and corporate management often equate to supernormal returns. The impact of capital allocation decisions is often less obvious in this case. In difficult times (e.g. from 2008 to 2021), the value added by capital allocation decisions is more pronounced, often making key contributions towards retirement funds achieving their investment target. The collective capital allocation decisions taken by trustees, asset managers and corporate management serve to buffer retirement fund returns against low domestic economic growth.

The relationship explains why retirement fund investment portfolios often perform better than the growth rate of the domestic economy.

Despite the positive contribution from these collective capital allocation decisions, long-term investment returns are still highly dependent on the domestic economic growth rate.

The role played by these collective decisions becomes more important when domestic economic growth wanes, as it has done since 2008. Retirement funds now rely on skilful management and astute decisions by trustees, asset managers and corporates to make up for the lack of robust economic growth. Therefore, it is important that retirement funds appoint skilful trustees and the best service providers, e.g. investment consultants and asset managers.

But why is the South African economy performing below expectations?

South Africa’s competitive position in the world is steadily declining. The Global Competitive Index[1] (which is reported on in the Global Competitiveness Report released by the World Economic Forum), includes more than 98 factors, which are grouped into 12 pillars – i.e. institutions, infrastructure, information and communication technology adoption, macroeconomic stability, health, skills, product market, labour market, financial system, market size, business dynamism and innovation capacity. Each of the factors/pillars is rated, and each country’s position relative to other countries and its own rating can be assessed.

For example, in 2008, South Africa was rated 45th out of 133 participating countries, but by 2019, it was rated 67th out of 141 participating countries.

Predictably, South Africa’s overall rating is negatively affected by specific factors such as health (118/141), safety and security (135/141), labour flexibility (111/141) and utility infrastructure (92/141). However, other factors such as checks and balances (e.g. budget transparency, judicial independence, legal framework and freedom of the press) (16/141), its financial system (19/141) and corporate governance (26/141) support South Africa’s rating.

Noteworthy is that some of the positive factors had been rated higher as recently as 2017. In 2017, South Africa rated 11/138 for its financial system and 1/138 for some sub-factors included in corporate governance (e.g. auditing and reporting standards, efficacy of corporate boards and protection of minority shareholders’ interests).

It is clear that South Africa’s competitive position globally has come under pressure since 2008.

In an editorial The economy is like a garden, DIG IT? released on 19 March 2021[2], Simeka Consultants and Actuaries commented on some of the causes for the South African economy’s sustained disappointing performance. The editorial summarised the factors that result in ongoing modest economic growth:

  • Poor state of government finances;
  • Unemployment;
  • Load shedding;
  • Pervasive inequality in South African society;
  • Government policy;
  • Corruption; and
  • Poor education outcomes.

The editorial concluded that some of the factors leading to economic underperformance require time to be addressed (e.g. poor education outcomes), but that some steps can be taken in the short term to boost the economy’s performance (e.g. prosecution of corruption, pro-growth economic policies etc.). It must be acknowledged that some progress has been made since the editorial was published in March 2021 (e.g. infrastructure initiatives, privatisation of SAA, steps taken to prosecute those accused of corruption, Fitch revising South Africa’s outlook to “stable” and affirming its “BB-” rating), but the question remains whether enough has been done. It seems that many of the conclusions drawn in the editorial in March 2021 remain valid and applicable today.

An important factor that was not explored in the 2021 editorial, is the impact of leadership on economic growth. Benjamin Jones at Northwestern University and Benjamin Olken at the Massachusetts Institute of Technology published a noteworthy paper Do Leaders Matter? National Leadership and Growth Since World War II. In the paper they concluded that “countries experience persistent changes in [economic] growth rates across leadership transitions, suggesting that leaders have a large causative influence on the economic outcomes of their nations” (Quarterly Journal of Economics Volume 120, Issue 3; August 2005; p861)[3]. Jones and Olken’s conclusion resonates, because as we know, leadership matters at a corporate level. Why would it be different at a national level?

From this perspective, it would be ideal for South Africa’s leadership (the President and the governing party) to (1) formulate, (2) regularly review and, when necessary, (3) change its policy approach with economic growth in mind, rather than from a predefined ideological position.

The policy obstructions highlighted in Simeka’s editorial comment in 2021 included:

  • Land reform where a fair and an equitable approach is required to promote access to economic opportunities;
  • National Health Insurance that appears to be unaffordable in its present form;
  • The National Minimum Wage policy which, it could be argued, contributes to South Africa’s very high unemployment rate; and
  • State-owned enterprises that operate inefficiently in near-monopoly conditions (e.g. Eskom, PRASA and Transnet).

Further issues to be addressed include improved education outcomes in South Africa, and the Mining Charter that is perceived to move empowerment goal posts almost continuously.

Again, meaningful improvement has not been evident since 2021. Along with infrastructure development and renewal, the four policy issues alluded to above are crucial to see an acceleration of South Africa’s economic growth in the short term. The IMF’s projections of economic growth for South Africa remain modest.

South Africa’s leaders have the opportunity to kick-start economic growth by addressing the fair and equitable distribution of land, finding an affordable solution to healthcare, implementing a labour policy that leads to job creation, and abolishing Government’s monopoly control over failing industries such as electricity supply, harbours and the rail network. It is not difficult to imagine that by addressing these issues, South Africa could accelerate its long-term economic growth from the current projected level of 1.3% to a level closer to 4.3%.

Economic growth and retirement funds’ long-term investment returns

If the long-term economic growth rate in South Africa accelerates from the prevailing modest levels, it will become much easier for retirement funds to achieve the target investment return of 5% to 6% above inflation and after fees – with less reliance placed on the contributions from trustees, investment consultants, asset managers and corporate management. Conversely, if there is no acceleration from the current modest economic growth rate in South Africa, it will become increasingly difficult for retirement funds to achieve an acceptable long-term target return above inflation and after fees.

It seems that, based on a base case outlook for the next 5 to 10 years, retirement funds will have to rely on value add from items (2) to (4) in the table, and therefore need to take the greatest care when appointing service providers in the prevailing modest to low domestic economic growth era.


[1] https://www3.weforum.org/docs/WEF_TheGlobalCompetitivenessReport2019.pdf

[2] http://www.simekaconsult.co.za/wp-content/uploads/2021/03/the-economy-garden-19032021.pdf

[3] https://academic.oup.com/qje/issue/120/3