Old Mutual cautions on the other side of risk

When it comes to retirement fund investing, risk is generally viewed by many as the chance of losing capital. However there is another aspect of risk that is equally important – the chance of not making enough capital.

According to Craig Aitchison, MD at OMAC Actuaries & Consultants, it is crucial that trustees and retirement fund members take both these views of risk into account when setting an investment strategy.

“While there are certainly large risks involved for members who are invested too aggressively given their risk profiles, there are equally large risks for members of a retirement fund that is too conservatively invested.

In this situation, a real risk exists that the returns o­n members’ savings may turn out to be lower than expected and that ultimately, the members retire with too little money to provide for the rest of their lives.

Aitchison says that while risk mitigation strategies implemented by trustees often reduce the chance of capital loss, they may inadvertently raise the possibility of impaired capital growth.

For example, blending asset managers reduces the risk of o­ne particular manager underperforming. But this strategy could also lead to dilution of strong performance by a manager. A similar situation exists for purchasing guarantees, which bring with them a higher cost of capital as well as high levels of diversification, which can reduce the impact of good calls.

According to Aitchison, there are several risk mitigation strategies to reduce the possibility of members not having enough capital at retirement. These include aggressive asset allocation, dynamic hedging and the use of replacement ratios.

He stresses that it is important to take into account the risk profiles of members when looking at how conservative or aggressive investments are. “The risk of being too conservatively invested is the greatest for younger members. Generally speaking, younger members can afford to take more risk, and should prefer more aggressive investments, as they can ride out adverse market movements.

Aitchison urges trustees to take both risk elements into account, and ensure that their members have the option to invest in products that offer both growth.

“The golden rule for a fund is to take o­n the level of risk that members can afford – not more, not less.”

Members can also manage investment risk by consistently preserving their retirement savings when switching jobs. “Should members have preserved their benefits right up to retirement, they need be far less concerned about volatility risk when they exit their fund, and can potentially even boost their ultimate returns by assuming higher levels of investment risk for longer during their working lifetime,” he concludes.