Old Mutual Provides Advice to Retirement Funds in the Wake of the Global Financial Crisis

The global financial crisis in international markets has caused much uncertainty amongst South Africans concerned about the effects of these events o­n their retirement funds. Seelan Gobalsamy, Executive General Manager at Old Mutual Corporate provides answers to the typical questions currently being asked by retirement fund members and trustees.

Q1 The past few weeks has seen the demise of some large institutions. What is happening?

On 15 September, the news broke that some of America’s big names (Merrill Lynch, Lehman Brothers and American International Group - AIG) were either o­n the brink of collapse or already looking for bankruptcy protection. This led to a huge drop in US and worldwide stocks. All three of these companies had large “sub-prime” related exposures.

In an attempt to contain the crisis, Bank of America bought out Merrill Lynch and the US Government announced an approval of an $85m loan to struggling AIG, o­ne of the world’s largest insurers.

Q2 What has happened to make global financial markets weaken further?

Equity markets fell around the world o­n Monday 29 September o­n news that the US House of Representatives rejected a government bail-out plan for US financial institutions that would have earmarked US$700bn to purchase bad debts from institutions whose balance sheets have been weakened as a result of the credit crisis and weak housing market.

An approval of the bail-out would have restored confidence in the credit quality of US financial institutions, preventing more banks from collapsing, halting deterioration of their balance sheets and encouraging improved lending in the US financial system.

With the bail-out proposals currently making their way through the US legislature, the health and credit quality of US financial institutions remains questionable, causing reluctance among banks to lend to each other and sharply reducing liquidity in the interbank market. At the same time, financial markets dislike uncertainty. Investors sold stocks with the view that the lack of a government bail-out would halt lending to businesses, sparking a collapse of the US financial system and causing a recession in the US economy. This would also exacerbate the current slowdown in world global growth, particularly in developed economies.

Q3 What is the impact o­n the South African economy?

Old Mutual Investment Group South Africa (OMIGSA) says the credit crisis will impact the local economy in so far as slower growth in the US and rest of the world will reduce the demand for our exports, including commodities. This will contribute to slower SA economic growth and lower-than-expected earnings for some of our companies.

The rand could also continue to come under some pressure as offshore investors sell South African stocks and remain cautious about emerging markets in general.

However, there are some positive factors that make the South African economy relatively less vulnerable than many. A weaker rand will help boost exports over the medium term. o­n top of this, slower global growth prospects have already contributed to a fall in oil prices, which, if sustained, will help contribute to lower inflation and, eventually, interest rates.

For now, our relatively high interest rates (compared to most other emerging markets) also make South Africa an attractive investment destination. In addition, government and private infrastructure spending continue to provide a solid platform for economic growth, which will likely help us avoid a recession.

We have recently seen upward revisions in economic growth expectations among most analysts. Despite this, many risks remain, including the possibilities of a sharply weaker rand and/or further shocks in the oil price

Q4 What about the weakness in South African financial markets?

In fact, the equity market weakness we have seen in recent weeks is a result of the global nature of financial markets.

Our financial markets cannot escape the global fallout – currently driven almost purely by fear – so our stocks have been punished along with those worldwide. The FTSE-JSE All Share Index is currently down a total of 28.7% (latest data available) from its peak in May 2008 to date. However, most of this decline does not reflect the true state of SA company earnings, with o­nly a few exceptions.

Investors should consider that, after over five years of a strong bull market in equities, this decline of 28.7% is o­nly a small percentage of the huge total gain of 388% recorded by the All Share Index from April 2003 to May 2008. For the entire period April 2003 to 30 September 2008, the All Share Index’s total returns are still 270.5%.

Q5 What is the impact of the crisis o­n SA financial institutions?

South Africa’s financial system, and its constituent financial institutions including banks and insurers, remain sound, with very little – or no, in some cases – exposure to the types of bad debts at the heart of the US financial crisis. The balance sheets of South African financial institutions remain strong, and there is no uncertainty in their credit quality. This means there should be no reluctance to lend among local financial institutions.

Q6 What should I as a retirement fund Trustee do to ensure my members are protected?

It is critical for us to remind ourselves that retirement planning and investing needs to be based o­n the long term.

It is important to review investment policy statements in light of the volatility, however prudent policies should have resulted in the necessary protection being taken against the current volatility.

Exiting member need to be protected against this sort of volatility.

Most South African retirement funds have some offshore (including US) exposure as part of their mandate. US equities have fallen in value and this will affect performance for all funds that have US exposure.

The failure of AIG, Lehman Brothers and Merrill Lynch has had an insignificant direct impact o­n returns for most South African retirement funds.

In general, retirement funds invested in balanced investment portfolios should be more focused o­n the overall level of the market (which affects all investors). The JSE is currently in a bear market which is bad news for (in particular unprotected) investors, but it is o­nly through staying in the market that o­ne can hope to benefit from its recovery.

Retirement funds invested in guaranteed products such as the Old Mutual Guaranteed Fund and the Absolute Growth Portfolios have the additional benefit of smoothing investment returns to reduce the impact of sudden fluctuations in the market.

Q7 What should I as a retirement fund member do about the exposure my assets have to the equity markets?

Members of retirement funds that offer investment choice should remember that investment markets are volatile, and they should make decisions based o­n long-term expectations rather than short-term market volatility.

If members have made their investment choices taking their long-term needs into account, they should not have to change investments because a particular investment, or the market as a whole, is experiencing a short- or medium-term fluctuation. Members might o­nly consider changing investments if they expect that there has been a permanent long-term change in the structure of an investment category or the whole market, and that prices will not return to long-term expectations. Experience shows that this seldom actually happens.

Furthermore, if members’ long-term needs change, they should then consider adjusting their investments to reflect those new long-term needs.

Q8 What is the way forward?

According to OMIGSA, the US Congress is very likely soon to pass some form of bail-out package for troubled US financial institutions, which will help restore stability to the US, and global, financial systems. This, in turn, should help stabilize world financial markets. However, there are sure to be at least a few more instances of bad news in terms of bad debt and unexpected write-downs and impairments for some institutions in the coming weeks and months. This means the roller coaster ride for investors is likely to continue as well.

The likelihood of the US Congress voting down all proposed forms of a bail-out plan is very small, as US lawmakers certainly recognize their responsibility to help restore confidence in the US financial system. While no o­ne can know for sure what the repercussions of such a plan will be, the direct impact o­n South Africa and South African investors will also be small. We can expect increased global regulations and restrictions with which our financial institutions must cope. Investors, meanwhile, are likely to benefit from some heightened regulation of certain instruments.

We also have no way of knowing how the financial markets will behave in the coming months. History has shown, however, that equities have always recovered after falls. In South Africa, for example, o­ne of the last bear market runs in 1998 saw the FTSE-JSE All Share Index lose approximately 30% of its value over four months, but all of this loss was regained within less than a year.