May 12, 2020
Generating returns ahead of inflation is crucial for sustainability of income in retirement. However, it is widely accepted that returns that exceed inflation cannot be achieved without taking risk. A previous article,The importance of growth assets for living annuity investors, penned by Ninety One Advisor Services Director Jaco van Tonder, discusses the need for exposure to risk assets to be able to grow your capital and maintain your income in retirement.
The COVID-19 pandemic has severely compromised freedom of movement and has contributed to a devastating impact on local and global markets. To put the volatility into perspective, at the time of writing, this current crisis has seen the S&P 500 post its fastest ever 30% decline, followed by a material recovery. Our local market fell below 37 000 points – only for it to close just below 50 000 on 14 April. While drawdowns can be severe, inflection points in the market can be equally rapid and pronounced.
Uncertainty about the duration of the crisis and concerns over further market declines have caused many investors to switch into ‘safer’ assets. However, we would caution against switching into cash, particularly in an environment where we have seen two 100bps rate cuts reducing the repo rate to just 4.25%. What’s more, there is the potential for further cuts. The returns from the money market over the past ten years are therefore not a reliable indicator of what investors will experience going forward.
Retirees in living annuities face an extra challenge during these times. Their requirement for income forces them to make regular withdrawals from their investments at a time when the capital value has been reduced significantly. Many feel that selling into weakness to fund their monthly annuity will have a negative impact on the sustainability of their income and therefore switch into cash to preserve the value of their nest egg. While this instinct to try and avoid further capital erosion is understandable, in practice this behavior often has the opposite effect to what was intended. Simply preserving capital is not enough because its value is eroded by inflation, and this effect is magnified when an investor also draws an income.
While the causes, magnitude and duration of previous market crises are always different, there are consistent learnings that we can glean from each. So, what lessons could the Global Financial Crisis (GFC) of 2008 teach pensioners in navigating the current environment?
To address this question, we looked at a scenario where a client retired at the beginning of 2007, the year in which the GFC began. The client invested R5 million into a living annuity, drawing a 5% income with the rand value of the income escalating by inflation each year. We then considered three scenarios using the Ninety One Opportunity Fund (the Fund) as the underlying investment:
We matched the rand value of the income drawn in all three scenarios. The outcome of the analysis (as at 31 March 2020) can be seen in Figure 1.
Figure 1: Remaining invested delivered the best outcome
The difference in outcome is astounding:
It is clear that the strategy of remaining invested delivered by far the best outcome for retirees. Importantly, the capital value continued to appreciate but of greater significance is that the percentage income drawn remained within acceptable parameters over the near 13-year time horizon (1 January 2007 to 31 March 2020). In the market timing scenario, the level of income has started to reach a concerning level and the retiree may need to consider making some lifestyle adjustments. In the permanent switch to cash scenario, the percentage income drawn has escalated to a point where the pensioner will need to come up with another plan to fund retirement in their later years.1
The strong returns of the Ninety One Opportunity Fund helped deliver this outcome, but the manner in which they have been generated has been equally important.
The Ninety One Opportunity Fund focuses on producing absolute returns; therefore, downside protection and avoidance of permanent loss of capital is core to the investment philosophy. This is particularly important for investors who are drawing an income. 2
More stable returns increase the probability that members remain invested through difficult conditions where the drawdown of a more aggressive investment strategy might tempt them to move into cash. Over the highly volatile first quarter of 2020, the Ninety One Opportunity Fund (A class) showed its mettle to preserve capital for investors, materially outperforming its peer group (the ASISA Multi Asset High Equity sector).
Since its inception, the A class of the Ninety One Opportunity Fund has delivered 13.5% p.a, versus 12.7% p.a. for equities over the same period (approximately 20 years). This equates to a 157% improvement in the cumulative return. Importantly, the annualised returns have been delivered at half the volatility (annualised standard deviation of equity: 17.4%; Ninety One Opportunity Fund: 8.6%).
Figure 2: Ninety One Opportunity Fund – producing equity-beating returns at half the volatility since inception
While attractive returns over time are important for long-term investors, the volatility of returns also has a material impact on the sustainability of retirees’ income. For living annuity clients in particular, a fund with more dependable returns is far more desirable than a fund with volatile performance.
Finding more dependable returns regardless of market conditions should be the ultimate goal of all investors, whether saving for retirement or drawing an income from those savings. Consistently applying a disciplined investment process helps ensure that outcomes are more predictable. Balancing risk and reward, the Ninety One Opportunity Fund seeks to deliver steady returns to patient investors, even as markets fluctuate.
The one thing that retirees are blessed with is a long investment time horizon. Starting with the correct investment strategy means that the best course of action during periods of volatility is to sit back and do nothing. This is easier said than done, but lessons from past crises indicate that by following this discipline, retirees will be rewarded by improved outcomes over the long term.
1 The importance of picking a safe income level is discussed in this article: https://ninetyone.com/en/south-africa/how-we-think/insights/living-annuity-an-activesolution/a-sensible-income-strategy-is-critical-for-living-annuity-investors
2 Why volatility matters for living annuity investors: https://ninetyone.com/en/south-africa/how-we-think/insights/living-annuity-an-active-solution/why-volatility-matters-for-livingannuity- investors
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