Expected after-inflation investment returns to June 2025
By Marcus Rautenbach, Principal Investment Consultant and Pieter Buitendag, Investment Consultant
Every year we frustrate investment managers on behalf of our clients with a simple question:
Using your unique insights, philosophy and process, what investment returns do you expect to earn above inflation over the next five years for the following:
| · Domestic shares | · Domestic money market |
| · Domestic nominal bonds | · Offshore shares |
| · Domestic inflation-linked bonds | · Offshore bonds; and |
| · Domestic listed property | · Offshore cash |
The purpose of the exercise is threefold: firstly, to develop an understanding of how expectations have changed since last year; secondly, to confirm that the investment objectives we use for retirement funds remain realistic; and finally, to assist retirement fund members with realistic assumptions to use in their retirement planning.
The investment managers we approach are the custodians of the nation’s savings, with a dominant combined market share of the savings industry. It is also those investment managers who have large dedicated research teams on which to rely.
The financial services providers who responded to the survey include:
| · Abax | · Ninety One |
| · ABSA | · Old Mutual |
| · Alexander Forbes Investments | · Prescient |
| · Allan Gray | · Prudential |
| · Coronation | · PSG Asset Management |
| · Fairtree | · Sanlam Investments |
| · Foord | · Stanlib |
| · Momentum | · Truffle |
As with any survey of this nature, the submissions must be perused to ensure that a rigorous discipline has been followed, but without negating any of the unique expectations of any particular investment manager.
The results of the survey for 2020 are as follows:
Table 1: Expected after-inflation investment returns over next five years: June 2020
| Asset class | Number of responses | Average % p.a. | Standard deviation of forecasts % | Lowest % p.a. | Highest % p.a. | Normalised range of returns at 95% level of confidence (% p.a.) | ||
| Domestic | Shares |
16 |
6.4% |
2.2% |
4.0% | 11.0% | 2.1% |
10.8% |
| Bonds – Nominal |
16 |
5.1% |
1.8% | 3.7% | 11.0% | 1.5% |
8.6% |
|
| Bonds – Inflation |
13 |
4.2% |
1.7% | 2.5% | 9.5% | 0.8% |
7.7% |
|
| Property |
16 |
6.7% |
2.8% | 3.0% | 14.0% | 1.0% |
12.3% |
|
| Cash |
14 |
1.1% |
1.4% | -1.0% | 5.0% | -1.7% |
3.8% |
|
| Offshore in ZAR | Shares |
16 |
5.2% |
3.4% | -2.6% | 12.0% | -1.5% |
12.0% |
| Bonds |
16 |
-1.8% |
3.1% |
-8.2% | 3.0% | -8.1% |
4.4% |
|
| Cash |
12 |
-0.9% |
3.4% |
-5.5% | 4.5% | -7.7% | 5.9% | |
The survey results in table 1 reveal that the difference between the highest and lowest expected returns for each asset class is significant in the results of the 2020 survey. For example, the highest expected return for listed property over the next five years is 14% p.a. above inflation, while the lowest expected return for listed property over the next five years is 3% p.a. above inflation. The ranges of expected returns for domestic and offshore shares (in ZAR) are also wide. This may be due to contrasting views held by respondents as to the future exchange rate of the rand.
In contrast with previous periods, the ranges of expected returns for domestic nominal bonds and domestic inflation-linked bonds are wider than usual (7% p.a. in 2020, as opposed to 3.7% p.a. in 2019). This is unusual because bonds are more homogeneous than other asset classes. In addition, the bond market is efficient compared to the equity market, and the excess returns generated by investment managers in the domestic bond market are more modest than those in other market segments.
Table 2: Difference between highest and lowest expected after-inflation investment returns in survey
| Asset class | Difference between highest and lowest after-inflation expected return for 2019 % p.a. | Difference between highest and lowest after-inflation expected return for 2020 % p.a. | Change from 2019 to 2020 % p.a. | |
| Domestic | Shares |
4.9% |
7.0% |
2.1% |
| Bonds – Nominal |
3.6% |
7.3% |
3.7% |
|
| Bonds – Inflation |
0.7% |
7.0% |
6.3% |
|
| Property |
6.7% |
11.0% |
4.3% |
|
| Cash |
1.0% |
6.0% |
5.0% |
|
| Offshore in ZAR | Shares | 6.0% |
14.6% |
8.6% |
| Bonds |
7.7% |
11.2% |
3.5% |
|
| Cash |
5.2% |
10.0% | 4.8% | |
Changes to the expected returns from one period to another reflect the economic and social conditions that prevailed in the respective periods, but crucially, the starting point (i.e. current market prices) has a significant on expectations. If market prices today are demanding, the investment return expectations for the following five years are often lower than the investment expectations when market prices today are at a lower level.
Table 3: Expected after-inflation investment returns over next five years: comparison between 2019 and 2020
| Asset class | Average after-inflation expected return for 2019 % p.a. | Average after-inflation expected return for 2020 % p.a. | Change from 2019 to 2020 % p.a. | |
| Local | Shares |
5.8% |
6.4% |
+0.6% |
| Bonds – Nominal |
3.6% |
5.1% |
+1.5% |
|
| Bonds – Inflation |
3.0% |
4.2% |
+1.2% |
|
| Property |
5.3% |
6.7% |
+1.4% |
|
| Cash |
1.6% |
1.1% |
-0.5% |
|
| Offshore in ZAR | Shares |
5.2% |
5.2% |
0% |
| Bonds |
-0.1% |
-1.8% |
-1.7% |
|
| Cash |
-0.1% |
-0.9% |
-0.8% |
|
The expected after-inflation investment returns for domestic shares, bonds and listed property all improved from 2019 to 2020, while the expected after-inflation investment returns for the domestic money market and offshore interest-bearing assets are lower in 2020 than in 2019. Offshore shares remained unchanged in 2020 from 2019.
The expectations for domestic asset classes relative to offshore asset classes have improved. Logically, one would expect the industry to reduce allocations to offshore asset classes, but in follow-up discussions with some respondents, it was not clear if the industry will follow through on this issue.
The improved expected returns of domestic nominal bonds are noteworthy for two reasons:
- The anticipated premium of domestic shares over domestic bonds decreased from 2.2% p.a. in 2019 to 1.3% p.a. in 2020; and
- The probability of achieving a long-term investment objective of 5.5% p.a. after inflation and fees is increasing as more (lower risk) bonds are included in portfolios.
This implies that a higher allocation to lower risk nominal bonds can reasonably be expected. Again, it is not clear if the industry will follow through on this issue.
The expected returns for domestic listed property relative to domestic shares have improved. In 2019, investment managers expected domestic listed property to underperform domestic shares by 0.5% p.a., but in 2020 they expect domestic listed property to outperform domestic shares by 0.3% p.a. It should be noted that the level of conviction in the expected returns for listed property is low and the higher expected return for listed property is somewhat speculative.
What do the improved expectations mean for retirement fund members who invest in balanced solutions?
We consider the impact on three types of balanced solutions, of which the asset allocations typically are:
Table 4: Typical asset allocations for balanced fund solutions
| Asset class | Growth funds | Moderate funds | Conservative funds | |
| Local | Shares |
42.0% |
35.0% |
25.0% |
| Bonds – Nominal |
15.0% |
25.0% |
30.0% |
|
| Bonds – Inflation |
0.0% |
5.0% |
10.0% |
|
| Property |
10.0% |
5.0% |
0.0% |
|
| Cash |
3.0% |
5.0% |
15.0% |
|
| Offshore | Shares |
28.0% |
20.0% |
15.0% |
| Bonds |
0.0% |
3.0% |
3.0% |
|
| Cash |
2.0% |
2.0% |
2.0% |
|
| Total |
100.0% |
100.0% |
100.0% |
|
| Combined shares |
70.0% |
55.0% |
40.0% |
|
| Combined offshore |
30.0% |
25.0% |
20.0% |
|
The expected after-inflation investment returns over the next five years for balanced funds with asset allocations reflected in table 5 are:
Table 5: Expected after-inflation investment returns for balanced fund solutions
| Expected after-inflation investment returns | Growth funds % p.a. |
Moderate funds % p.a. |
Conservative funds % p.a. |
| As at June 2020 |
5.6% |
5.1% |
4.4% |
| As at June 2019 |
5.0% |
4.5% |
3.8% |
Table 5 shows that for the next five years from 2020, balanced fund solutions are expected to generate an after-inflation investment return of 0.6% p.a. higher than the five years’ expectations for the same funds in 2019. Even though an increase of 0.6% p.a. does not sound like much, it can lead to a healthy improvement in the net replacement ratio of those who currently still have some years of service remaining before retirement.
Informative as the average of the expected after-inflation investment returns of the custodians of our nation’s savings may be, financial markets seldom produce the exact “average” investment returns. To develop some understanding of how events may unfold, we apply four basic scenarios to the survey results, by either increasing or decreasing the expected returns by one standard deviation for each of the following scenarios:
Diagram 1: Basic scenarios: June 2020
| RAND | Weak |
Scenario 4 |
Scenario 3 |
| Stable | Scenario 1 |
Scenario 2 |
|
| SHARES |
Weak |
Strong |
|
Table 6 shows the results of the expected after-inflation investment returns over the next five years for each of the scenarios reflected in diagram 1:
Table 6: Expected after-inflation investment returns for the scenarios: June 2020
| Expected after-inflation investment returns | Growth funds % p.a. | Moderate funds % p.a. | Conservative funds % p.a. |
| Scenario 1 (weak share prices, stable rand) |
3.8% |
4.1% |
4.3% |
| Scenario 2 (strong share prices, stable rand) |
6.7% |
5.8% |
4.8% |
| Scenario 3 (strong share prices, weak rand) |
7.4% |
6.1% |
4.6% |
| Scenario 4 (weak share prices, weak rand) |
4.6% |
4.3% |
3.8% |
Using the results of the survey of investment managers’ expected after-inflation investment returns, one can tilt these expectations to reflect particular conditions that may prevail in the next five years. Interestingly, the expected after-inflation investment returns are more sensitive to share prices than to changes in the exchange rate of the rand.
Importantly, we do not advocate any particular scenario in table 6. Using the unadjusted results (table 5) may prove to be more appropriate. The scenarios in table 6 should serve only to stress-test the results reported in table 5.
In conclusion, one should note that investment managers’ after-inflation investment return expectations in 2020 have improved from 2019. Domestic assets are expected to outperform offshore assets in the next five years. Domestic bonds are expected to perform much better than previously, particularly when compared with the expected return for shares. Investment managers expect listed property to provide a better return, but the level of conviction accompanying this expectation is speculative.
Even though after-inflation investment return expectations for the next five years have improved over similar expectations in 2019, we believe it is not yet appropriate to adjust retirement funds’ investment objectives upwards. There is too much risk in economies and the financial system.
In the same way, we believe it is not yet appropriate to increase the investment return assumptions used to calculate net replacement ratios for retirement fund members.
It is important to note the investment managers’ improved expectations going forward.