What is going to happen to investment returns by 2026? – 20 August 2021
The annual survey of expected investment returns for the next five years shows that investors in balanced growth solutions can expect to earn 5.5% p.a. above inflation. This is one of the findings of a survey conducted among 21 respected investment managers on the expected investment return for each of the major asset classes for the next five years. The expected five-year return of 5.5% p.a. in the current survey compares with 5.6% p.a. in the 2020 survey and 5.0% p.a. in the 2019 survey.
Similarly, the five-year investment return for a moderate solution is expected to be 4.9% p.a. (5.1% p.a. in 2020 and 4.5% p.a. in 2019) and for a conservative solution 4.1% p.a. (4.4% p.a. in 2020 and 3.8% p.a. in 2019).
The balanced solutions comply with Regulation 28 in Annexure B of the Pension Funds Act (No. 24 of 1956).
The investment return expectations in the 2021 survey do not differ significantly from the results of the 2020 survey. Retirement funds and members may wish to maintain their investment objectives at similar levels to those in previous periods.
The question posed to investment managers was “Using your investment philosophy and process, what real investment return do you expect to achieve for each of the major asset classes in which South African retirement funds invest in the 5-year period to 2026?” The survey respondents were asked to provide expected returns for domestic shares, bonds, inflation-linked bonds, property, cash and offshore shares, bonds and cash.
Included in the group of investment managers surveyed were the providers of the top 10 balanced solutions, the larger multi-managers as well as some exciting upcoming investment managers.
Survey results of investment return expectations five years out:
| Asset Class | Expected after-inflation investment returns five years out from: | |||
| 30-Jun-21 | 30-Jun-20 | 30-Jun-19 | ||
| Domestic | Equity | 7.0% | 6.4% | 5.8% |
| Bonds – Nominal | 4.0% | 5.1% | 3.6% | |
| Bonds – Inflation | 3.0% | 4.2% | 3.0% | |
| Property | 4.5% | 6.7% | 5.3% | |
| Cash | 0.7% | 1.1% | 1.6% | |
| Offshore
(in rand) |
Equity | 5.6% | 5.2% | 5.2% |
| Bonds | -0.7% | -1.8% | -0.1% | |
| Cash | -0.5% | -0.9% | -0.1% | |
| Note: 2021 survey based on 21 responses, 2020 survey based on 16 responses, 2019 survey based on 13 responses | ||||
The survey results show rising real return expectations from domestic shares. This may be explained by the inclusion of more respondents in the survey. In 2019, the survey was restricted to the top 10 providers of balanced solutions; in 2020 the survey was expanded to include large multi-managers, and in 2021 the survey included the top 10 providers of balanced solutions, large multi-managers, and fast-rising providers of balanced solutions. We believe that due to the sheer size of their investment portfolios, the top 10 balanced solutions are not as flexible as the smaller but fast-rising balanced solutions. These investment managers may be able to tap into opportunities that are not available to large funds.
The real investment return expectations for domestic property were much lower in the 2021 survey than in the 2020 and 2019 surveys. We believe the uncertain state of the retail and office property markets led to the more modest expectations. A noteworthy feature from the detailed responses is that the investment managers of absolute return solutions tended to have higher return expectations for domestic equity and lower return expectations for domestic property over the next five years. Conversely, the investment managers of the top 10 balanced solutions maintained lower return expectations for domestic equity and higher return expectations for domestic property over the next five years. This phenomenon is peculiar and worth exploring in future research. Suffice to say that absolute return managers require a larger margin of safety from individual investment counters before taking up exposure. It is possible that the uncertain state of the property rental industry led to absolute return managers maintaining more modest expectations for this asset class.
The investment return expectations for domestic bonds (both nominal and inflation-linked) were lower in the 2021 survey than in the 2020 survey. Based on the survey results, it seems that there may be asset allocation alignments away from domestic bonds to shares.
With the survey data available, it is possible to do scenario testing to gain an understanding of the potential impact of larger themes in financial markets. We believe that the two most important themes that could impact the returns earned by savers are: whether equities will perform better than in the past; and whether the rand will weaken by more than the inflation differential between South Africa and its major trading partners. Simeka’s investment consulting team considered the expectations of equity performance and the rand. With equity performance as the x-axis and the rand as the y-axis, it is possible to create a matrix of potential outcomes and assign probabilities to each of the potential outcomes.
| Probability assigned to scenarios on 30 June 2021 | |||
| Rand | Weak | 25% | 41% |
| Stable | 9% | 25% | |
| Lower | Higher | ||
| Equity performance | |||
The survey shows a bias towards a more positive outcome for equity performance and a weakening rand. Adjusting the average return expectation for each of the asset classes by one standard deviation up or down depending on the impact of a weaker/stronger rand and higher/lower equity performance, one gains an understanding of what will happen to return expectations if the rand weakens/strengthens and equity performance turns out lower or higher than expected. The scenarios are not created to filter or change the survey results, but rather to develop an understanding of what will happen if the more important outcomes change.
The return expectations for each of the scenarios for growth, moderate and conservative balanced solutions are:
| Expected 5-year after-inflation investment returns for scenarios on 30 June 2021 | ||||
| Rand | Weak | Growth 4.7% p.a.
Moderate 4.2% p.a. Conservative 3.6% p.a. |
Growth 7.5% p.a.
Moderate 6.2% p.a. Conservative 4.7% p.a. |
|
| Stable | Growth 3.5% p.a.
Moderate 3.6% p.a. Conservative 3.6% p.a. |
Growth 6.9% p.a.
Moderate 5.9% p.a. Conservative 4.7% p.a. |
||
| Lower | Higher | |||
| Equity performance | ||||
The investment objective for those who save for retirement often is to earn an investment return of 5.5% p.a. more than long-term inflation after fees. The most likely expected 5-year after-inflation investment return of 5.5% p.a. (before fees) for a balanced growth solution is not quite there, but remains encouraging.
There are many variables at work in a retirement savings portfolio, which can never be accurately reduced to a survey. However, considering possible changes to the more important variables, the outcomes are symmetrically distributed around the most likely outcome, with the low outcome for a balanced growth solution at 3.5% p.a. after inflation for the next five years and the high outcome at 7.5% p.a. after inflation for the next five years. A similar level of symmetry prevails for moderate and conservative balanced solutions. Interestingly, the expected 5-year after-inflation investment returns for growth, moderate and conservative balanced solutions are compressed in the low outcome scenario.
| Expected 5-year after-inflation investment returns on 30 June 2021 |
| 30 June 2021 | Low outcome | Most likely outcome | High outcome |
| Growth | 3.5% | 5.5% | 7.5% |
| Moderate | 3.6% | 4.9% | 6.2% |
| Conservative | 3.6% | 4.1% | 4.7% |
So, what do we learn from the above?
- It remains important for each retirement fund member to have a long-term investment strategy and to select a suitable investment solution (fund manager).
- The survey of expected 5-year after-inflation investment returns (to 2026) shows similar results to the same exercise in 2020, and it is not necessary for retirement funds or members to change their investment objectives at this stage.
- The investment philosophies and processes used by investment managers lead to wide ranges of expected returns for domestic equity and domestic property. The investment managers of absolute return solutions maintain a more positive outlook for domestic equity and a less positive outlook for domestic property than the investment managers of the top 10 balanced solutions. It is unlikely that both sets of investment managers will be correct on this issue at the same time.
- Thus, correctly “reading” the environment, adopting appropriate benchmarks and selecting suitable financial services providers taking account of the current environment could be crucial over the next five years.