What real returns?

We're all basking in the low inflation environment in SA currently and it's making real investment returns look great for investors of all types.

I confess that I don't know a lot about how CPI is calculated or its sensitivity to seasonal issues but it seems that the measurement of CPI is subject to just the same sensitivity as retirement fund performancethat I have been discussing in these e-mails over the last couple of months.

We measureCPI year-on-year (y-o-y) so comparing this month's y-o-y CPI with last month's always depends on what one is adding on this month and casting off 13 months ago. The current y-o-y figure to the end of May is 0.6% but the inflation for the first five months of 2004 has been over 2%.

This is because there are some fairly hefty negative months in the y-o-y stat, i.e. the seven months of last year in the 12 month figure. So, unless we can clock up some more negative months to replace last year's, we may see inflation start to edge up soon.

Speaking of inflation, we all know that retirement funds deliver consistent real rates of return, right? The current fad of CPI-plus mandates aiming for about CPI+6% is viewed by many as aiming low and conservative, right? Well, the answer to both may be "wrong"!

I've gone back to data starting in January 1980 and finishing in March 2004 for average fund returns and the figures aren't that impressive.

Take the rolling 36 month figures below. There have been a total of 176 rolling 3 year periods in the analysis. Some of the more historic data is quarterly - hence fewer periods than one might expect.

Good news - all 176 periods produced positive returns. 170 periods beat inflation which isalso good news. However, less than two-thirds of those rolling 3-year periods beat inflation by 6% or more! The figure is only marginally better if one excludes the high inflation years and prescribed assets of the 1980's.

Even over 5 years the average fund has beaten CPI+6% only 70% of the time. Bearing in mind that these returns are gross of manager fees, fund expenses and retirement funds tax, one can take at least 2% per annum off so the average fund would have achieved a net return of CPI+4% only 65% of the time over the last 25 or so years.

So real returns haven't been that impressive in some periods and CPI+6% may actually be a challenging target.