Loss-averse investors must balance risk with value

Many South African retirees are chronically underfunded, a situation that becomes more problematic when loss-averse investors over-allocate savings to conservative products. Yet there are solutions available that enable investors to balance their risk pro

Capital guarantees may offer peace of mind, but taking fees into account the veneer of safety they provide produces a far more beneficial impact for life company shareholders than they do for policyholders.

Closing institutional portfolios is a recent trend that has seen some popular asset managers corralling would-be savers into higher-cost, retail fee classes to chase historic performance, thus transferring the very returns sought after back to the fund managers.

Smoothed bonus funds, which reduce perceived portfolio volatility by averaging out the distributions received by members over time, sometimes cloud this attribute with cross subsidisation, black box bonus declarations and frequent deviations between realistic return expectations based on current market performance and actual bonuses declared.

One solution to the issues described above would be an investment structure capable of sufficient flexibility to shield its participants against loss, yet responsive enough to capture upside. It would also need to be implemented in such a manner as to soften the impact of volatility, which so often leads to rash choices at market extremes, while still providing meaningful market linked returns in line with expectations.

The way to achieve this is to focus on the three primary characteristics desired in a long-term, stable growth fund.

First, drive returns over time by an aggressive allocation to growth assets in a balanced fund. Constructing this fund passively, using ETFs and other cost effective implementation methods allows for market linked performance without eroding returns through excessive active management fees. Where active returns are desired, take advantage of the new amendments to Regulation 28 and obtain them in alternative asset classes such as hedge funds, unlisted property and private equity where the ability to provide CPI beating returns also adds the benefit of good diversification from listed assets.

Next, preserve capital and hence minimise the range over which smoothing needs to take place by instituting a risk management philosophy focused on protecting the asset base. Tactically linking asset class exposure to observable and objective market variables such as yield and the cost of protection further optimises the fund’s ability to switch between preservation and growth.

Finally, incorporate the desirable attributes of smoothing technology in a transparent and open fashion that is easily understood by members. Ensuring the smoothing takes place in conjunction with risk management also minimises the potential for cross subsidisation between members, as well as reduces the divergence between return expectations and bonus declarations.

By fusing these components, investors end up with a new generation solution to the age old challenge of balancing risk and return with value for money.