Monetary policy response to mitigate Covid-19 leaves pensioners in the lurch

Gerrit Craucamp, Head of Investment Strategy at Novare Actuaries & Consultants

While recent interest rate cuts have been welcomed by business and cash-strapped consumers whose debt will cost less, pensioners dependent on interest earned from savings will suffer a significant decline in income - especially with further rate cuts on the cards.

Gerrit Craucamp, Head of Investment Strategy at Novare Actuaries & Consultants, pointed out that, while pensioners have enjoyed the benefit of high interest rates for some years, cuts announced so far this year have erased about one-third of their interest earnings.

At an unscheduled meeting of its monetary policy committee, the SA Reserve Bank recently reduced lending rates to record lows in response to the economic turmoil caused by the Covid-19 pandemic. Governor Lesetja Kganyago said the bank expects the economy to contract by 6.1% in 2020. The usually conservative central bank cut its lending rate by another 100 basis points to 4.25%, and signalled that further cuts could follow. This after it had cut rates by 100 bps in March and by 25 bps in January.

The reduction saw the repo rate, the rate at which the Bank lends to commercial banks, reach its lowest level since 1973, resulting in SA’s prime commercial lending rate dropping from 8.75% to 7.75%.

Said Craucamp: “Unit trust investors, retirement fund members and holders of retirement annuities would have opened their first quarter investment statements with some trepidation. March has been described as an unprecedented month for investments, with almost every asset class suffering heavy losses in the first quarter of this year.

“For retirement fund members, many pension funds employ a life phase model in terms of which members’ money is systematically moved to more conservative portfolios as retirement approaches. As a result, their investments will to a certain extent been protected against the sharp sell-off.

“The best thing to do if you have the time is to stay invested and wait for your investment to improve with the markets. Some members close to retirement might be able to delay and keep working. Alternatively, with depressed investment values, members are entitled to leave their benefits in the fund as a paid-up member and wait for markets to recover. Many, however, won’t have the luxury of choice - either in terms of the timing of their retirement, or the need to access now much-depleted capital.”

Moving assets out of a retirement fund into cash would, at this stage, only serve to lock in losses. Similarly, retirees who intend investing in a living annuity to provide their pension could consider reinvesting back into the market.

Importantly, annuitants should draw as little as possible as a pension because each monthly withdrawal while markets are down also locks in losses. To continue drawing a high income when returns are low in the first few years of retirement could permanently compromise the annuitant’s ability to support their income through retirement.

While younger investors saving for retirement can benefit from a market fall of the magnitude experienced because long-term returns are improved by acquiring stocks and bonds at attractive prices, for those already retired the trick is to balance income needs with the need to preserve capital for as long as possible.

Said Craucamp: “Especially in the current environment, there are no easy answers on how to maximise income. Generally speaking, savers enjoy more certainty and less risk when investing in bonds, fixed deposits and money markets – compared with property and shares.

“While the drop in interest rates comes on top of a likely steep drop in distributions from listed property investments, which many pensioners hold for the yield, the good news is that bond yields are high - which means guaranteed or life annuities are offering higher income streams than before.”

Investors could consider government bonds with maturities in the middle of the bond curve as prices dropped and yields spiked recently. This poses an attractive proposition amid the SA Reserve Bank’s low inflation expectations for the rest of the year. The yield on the R186 bond is at 9.0% and longer-dated government bonds are offering attractive yields of 11.6%

Considering the latest inflation forecasts from the Reserve Bank at 3.5% to 4%, government bonds are offering above-inflation returns of 5.0%% to 7.6%. Similarly, inflation linked government bonds are offering guaranteed above-inflation returns of 4.0% to 4.4% no matter what happens to inflation.

“The worrying state of government’s finances saw Moody’s Investors Service drop SA’s last investment grade rating for its sovereign bonds last month. The drop to junk will force SA’s government bonds out of the World Government Bond Index (WGBI), which tracks investment-grade government debt. Many passive investment funds follow the index and active managers are mandated to allocate a percentage of money to investment-grade debt. These funds will have left SA at the end of April when the country drops from the index, and we can expect increased volatility in the bond market,” said Craucamp

He also noted that pensioners enjoy income tax exemptions on the interest they earn, and this helps make RSA Retail Saving Bonds a compelling option that pays an interest rate of about 11.5%. Funds can be accessed before the end of the term, but a penalty would apply.