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Saving for retirement : active or passive choice?

01 April 2014 Joseph Pearson, Momentum Asset Management

In a country with a low savings rate, passive investment products offer a cost-effective and predictable investment solution. Investing in indexed products makes sense from a fee and return perspective as they provide affordable, easy access to diversified portfolios.

Due to the abiding sense of uncertainty in the current global economy, predictability is becoming a highly-sought-after commodity for investors. South Africa, as part of the ‘fragile five’, has been particularly affected by this instability as emerging markets experience an outflow of capital due to the tapering of the US Federal Reserve’s quantitative easing programme and resultant reduced global liquidity. Our country’s high debt burden and poor economic reform have made us particularly vulnerable to this withdrawal of funds and taking unnecessary investment risks is therefore inadvisable. Finding cost-effective, stress-fee ways of accessing maximum asset class exposure has become more important than ever.

Unveiling the secret

Managing risk in investments is all about finding the best way to achieve a target with the lowest probability of not reaching the desired outcome. The asset class mix needs to be designed to meet client wealth objectives and incorporate inflationary targets over specific investment periods. “Considering the asset class combination that is most likely to achieve inflation-beating returns over the savings time frame then becomes the next step as allocation blends can be designed in such a way that they maximise the probability of achieving this outcome,” says Joseph Pearson, Portfolio Manager at Momentum Asset Management.

Index tracking, or passive investing, contributes to effective savings practice in a number of ways. It assumes that markets are generally efficient and reflects the collective wisdom of all market players. It also facilitates the optimal distribution of capital, which, in turn, leads to investment monies being allocated more meaningfully, especially in terms of investor life stage. Passive investing does, however, involve the active choice of asset class exposure, benchmark and application of style or alternatively-weighted indices, thereby also providing the diversification necessary to predictable returns and improved risk management, which remain a critical component of the active investing process and active manager’s skill set.

As funds are now able to invest 25% offshore (ex-SA and Africa) and 5% in African stocks, exposure to offshore investment opportunities is increasing. The benefits of including offshore asset classes are illustrated in figure 1. The efficient frontier, which includes offshore assets, provides improved return per unit of risk when compared to portfolios consisting of domestic-only assets. This provides potential for cost-effective growth, which is important in a global economy where uncertainty persists and the generation of consistent, inflation-beating returns through diversification is paramount.

Figure1: Efficient frontier (risk vs. return) 2009 to 2014

Source: Factset, Momentum Asset Management

“Such prospects, however, come with concentration, geographic and political risks, especially in relation to Africa, and their potential as value drivers could be better assessed and monitored through the use of custom indexing,” adds Pearson.

An active debate

Although South Africa is starting to follow the offshore trend, uncertainty around international investing and advisor accountability are proving somewhat of a deterrent to venturing into passive investment. Liability profiles being defined and measured in accordance with a benchmark may reduce associated fears. Financial intermediaries in the retail space are also incentivised to sell active products and the current debate around fees and performance may also generate better flows into index-tracking portfolios.

Educating clients on how to make the most of their money and adopt appropriate, bespoke investment solutions may assist in addressing our country’s worrying, low-savings statistics,” concludes Pearson. “Passive investment products afford the mass market the opportunity to benefit from the active application of cost-effective return driver mixes, thereby bolstering proper retirement planning.”

Quick Polls

QUESTION

South Africa went to Davos to pitch itself as an investor-friendly destination, then signed an Expropriation Act. What message does this send to global investors?

ANSWER

Invest at your peril
SA is open for business
Two steps forward, one land grab back
Welcome to Hotel California
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