Lessons for Retirement Funds
It’s been just over twelve months since Lehman Brothers failed, proving to be the catalyst for a series of events that came close to destroying the world’s financial system. With huge volatility in stock markets on both local and global markets, the past year has been an especially difficult time for pension funds, many of whose members have the bulk of their life savings invested in them.
With the global economy having stabilized somewhat, the anniversary of the Lehman collapse is an opportune time to highlight the lessons that pension fund trustees and members can learn from these events.
Assets revert to their true value
History has shown that the prices of assets will eventually revert to their true value. The rampant increases in the equity markets in 2005 - 2007 meant that the price of equities in all likelihood outstripped their true value.
As such, it can be argued that although the timing may have been difficult to predict, we should have expected a correction. The world equity risk premium - the compensation for additional risk you take by investing in equities rather than secure government bonds - for 2008 was the lowest, at -40%, since the great depression. The market fall of 2008 was a correction of the inflated returns up to 2007. In effect, if we look at long-term statistics, we were borrowing from the future up to 2007.
We need to ask ourselves what is supporting and driving underlying growth. For example, the housing bubble of the last few years was similar to the dot.com bubble of 2000, which were both driven by over inflated prices and expectations
Diversify appropriately
When it comes to growth assets, we need to consider asset classes other than equities, such as direct property, and alternative investments, such as hedge funds and private equity. Trustees and members of retirement funds should take the time to understand these asset classes, which offer alternative growth opportunities and are less closely linked to the general equity markets.
The performance of these alternative asset classes does not closely follow that of equities, making them excellent diversifiers in a portfolio, while at the same time bolstering returns. Direct property and private equity outperformed general equities over the seven- year period to the end of 2008.
Review and refine investment strategy
In turbulent times, it is important for trustees to review the longer-term investment strategy for their funds and ensure that it remains appropriate and suitable to meet their goals. This does not mean you should over-react. Cash is not always the best option. There is a risk that members may end up moving to cash and remain inappropriately invested in this asset class for the medium to long term, reducing their long-term return objectives.
There is a need to focus on higher risk factors. For example, asset allocation decisions are far more important than trying to select the best manager. Getting your asset allocation decision wrong by as little as 1% may have a much bigger impact on your fund than not choosing the best performing asset manager.
Funds also need to focus on risk objectives and not just return objectives. Many funds have a CPI+x% return objective, but their members will not accept a negative monthly return. A singular focus on the CPI+x% return objective may result in the fund not adequately meeting member needs, which was the case over the last eighteen months.
Smoothing of returns is the most common example of addressing both these needs at the same time, and in some cases, allows you to be even more aggressive with your long-term return objective.
Educate and communicate
There is a large demand and recognition by the industry that member education needs to start at a basic level, and not just include retirement funding training.
Many members of retirement funds inSouth Africa have not had the training to understand fully the financial principles necessary to make the correct investment decisions on their pension fund assets. Training thus needs to start with the basic financial behaviors, such as the need for saving.
Communication is even more critical for funds with member-level investment choice. However, it is just as important to ensure members are educated in order to understand this communication.
Trustees, together with employers, have the responsibility and opportunity to offer training in this regard. Old Mutual’s Financial Wellbeing Program is a great example of providing free basic financial training to members of retirement funds.
Communication is even more critical for funds with member-level investment choice. However, it is just as important to ensure members are educated in order to understand this communication.
Trustees, together with employers, have the responsibility and opportunity to offer training in this regard. Old Mutual’s Financial Wellbeing Program is a great example of providing free basic financial training to members of retirement funds.
