Managing members’ investment return expectations

By Chinèll Lehmann, Investment Consultant

Retirement fund members are often split between two extremes – the ‘dreamers’ and the ‘market timers’. The dreamers pay little attention to their investments and believe that their retirement savings will continue to grow as they have done for the last five years. The market timers try to adapt their market strategies based on information at their disposal. This group reads financial journals meticulously, watches news like clockwork and monitors the published unit prices of their retirement savings.

The recent outperformance of the equity market may lead to both dreamers and market timers making irrational decisions which could affect their investments. The dreamers may make incorrect assumptions on the future growth rate of their assets, and make retirement plans based on faulty expectations. The market timers may unduly switch their assets in an attempt to time the market.

The state of the market
South African assets have provided stellar returns since the global financial crisis in 2008. In addition, the economic recovery of the developed world has seen the global portion of our retirement savings grow exponentially over the last two years. One would have to go back many years to find a period that all domestic and foreign asset classes performed this well at the same time.

In terms of our legislation, the majority of South Africa’s retirement fund assets remains invested in South Africa. A big driver of local returns until now has been the flow of foreign investment into our stock markets (bonds and equities). However, mounting risks and market pressures may bring an end to this ‘party’. In the past, when foreign investors have left South Africa, they have done so in droves, dealing massive blows to both local investment markets and the exchange rate. Furthermore, the domestic economy is increasingly hamstrung by low growth, increasing unemployment rates and resulting in a budget and current account deficit.

Local investment professionals concede that most South African investments are overpriced and don’t foresee that markets will continue to perform as well as they have done in the recent past. There is no way to accurately predict market returns, but it is fairly clear that there is a likelihood of lower (or even negative) returns over the medium term. The message to the dreamers is that although there has been good performance over the last period, the road ahead may be rocky.

There is unfortunately no crystal ball that can help us make the perfect investment decisions. No-one can predict what the market will do. According to some professionals, South African markets were already over-valued during 2013, yet the markets have continued to bolt to new record highs. It is therefore vital that members never attempt to withdraw assets from risky portfolios and invest them in less risky investment portfolios when markets are high, and then attempt to reinvest when markets are low. This is known as ‘timing the market’. It is not advisable for young market timers to get cold feet and improperly change their investment strategy. Young members should have a long investment view and not worry about short-term market movements.

How do retirement funds assist members?
To help protect both the dreamers and the market timers from making investment decisions that could lead to the destruction of value, many retirement funds offer a life-stage model as a default investment strategy. The long-term asset allocations of these portfolios are designed to provide the best possible returns given the volatility and risks inherent in the markets. As members approach retirement and become more vulnerable to market movements, the life-stage model systematically switches members’ fund credits from aggressive to cautious portfolios.

The life-stage model automatically personalises each member’s investment strategy by investing assets in appropriate portfolios depending on the member’s term to retirement. When the markets go up and down, it is comforting to know that the strategy is designed to ride the waves in the most efficient way. There is no need for either dreamers or market timers to do anything.

For retirement funds who do not offer a life-stage model, and provide individual member investment choice, communication becomes even more critical to help temper investment expectations, but also to warn against impulse switching or attempts.