Eking out an above-inflation investment return was a challenge for fund managers during 2018. The table below shows that the asset classes traditionally recommended to long-term investors, including those where most retirement funds are invested, showed below-inflation returns.
Note that the returns in the table below are in rands.
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Source: Profile Media and ETFSA*
So what does 2019 hold? Should investors simply invest in last year’s performers and target US equities and funds with high exposure to fixed-interest investments?
The World Bank releases a document predicting change in GDP growth levels every January. This year’s document, ‘Global Economics Prospects’, ominously subtitled ‘Darkening skies’, states that ‘….moderating activity and heightened risks are clouding global economic prospects ….downside risks have increased, including the possibility of disorderly financial market movements and escalating trade disputes’.
The World Bank table below shows that global growth is expected to slow from 3% to 2.9% in 2019. There is general consensus on this view. While Goldman Sachs, and JP Morgan are possibly the most bullish, Swiss Re’s view is that downside risk has increased because the economy has less capacity to absorb shocks, due to higher debt burdens and weaker financial market structures.
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Source: World Bank. Table notes: PPP = purchasing power parity, e = estimate, f=forecast.
World Bank forecasts are frequently updated based on new information. Consequently, predictions presented here may differ from those contained in other World Bank documents, even if basic assessments of countries’ prospects do not differ at any given moment in time.
*Aggregate growth rates calculated using constant 2010 US dollar GDP weights.
**GDP growth values are on a fiscal year basis. Aggregates that include these countries are calculated using data compiled on a calendar year basis.
But an expected drop in world growth from 3% to 2.9% is hardly dramatic. Some commentators – the most noteworthy being US-based Ray Dalio of Bridgewater – point out that the short-term cycle should be the least of our concerns. The real challenges according to Dalio are the underlying structural changes, including differential productivity levels and the long-term debt cycle. He believes that China is reaching the limits of debt accumulation.
A second US-based commentator, John Mauldin has also drawn attention to the consequences of slowing growth in China. In his latest newsletter, Bull in a China Shop, he writes that China is facing a shrinking labour force, reduced domestic demand and the relocation of Chinese-exporting companies due to rising domestic costs.
So how should long-term retirement investors respond?
US academic and market commentator Ben Hunt argues in ‘You Don’t Have to Dance Every Dance’, that as tensions rise, risks and unknowns increase; investors should respond by taking money off the table.
However, the traditional answer from institutional fund managers has it that equity performance is volatile, does not deliver returns in a straight line and that markets should not be timed. They encourage investors to stick with their long-term equity exposure come what may.
Fund managers themselves constantly seek ‘value at the right price’. They track a combination of share performance ratios which are compared with historic ratios to determine possible profitable buy and sell points.
To see evidence of a fluctuating exposure to equities, all you have to do is look at the typical equity exposure of multi-asset funds. As of December 2018, the South African equity exposure in the multi-asset high funds, (which are permitted to invest up to 75% of their portfolios in equities), ranges from 28.8% to 47.9%, with offshore equity exposure adding, on average, an extra 25%.
At Rosebank Wealth Group, our chief priority is to preserve capital value. Secondly, we believe that investors should take the necessary steps to ensure that they control the few aspects of the investing process that are certain and predictable. This means seeking out relatively low-cost, tax-friendly investments. Finally, we then look for growth opportunities to supplement the preservation of capital.
We believe that investors should have a core and satellite portfolio, which allows for tweaking as the investment environment fluctuates. This model allows for a basic core strategy, and a range of ‘satellite’ portfolios which are designed to either take advantage of new opportunities or ‘de-risk’ a portfolio as necessary. It also allows for introducing portfolios of non-correlated assets, as the need arises.
This strategy is easier if you have some investments which are not subject to retirement fund rules, as described by Regulation 28 of the Pension Funds Act.
Satellites are typically niche investment products that might be temporarily included in a portfolio as a result of favourable regulatory change, or a favourable re-rating due to new information or new technology becoming available.
- In the current market, a satellite could be designed to house underlying holdings that produce returns similar to the interest-bearing returns of unit trusts. However, the underlying holdings need not necessarily actually consist of interest-bearing investments, as these investments attract higher taxes. During 2018, some portfolios that invested in preference shares turned in very pleasing after-tax, money market-like returns.
- Investors can tweak the offshore portion of their portfolios, depending on where good value is perceived to be. During the 2018 year, some of our investors enjoyed relative outperformance by investing in niche equity investments with returns measured in US dollars.
- Satellites could also be designed to house alternative assets such as private equity investments. Some private equity investments are eligible for Section 12 J tax rebates, which have the potential to further enhance total performance. Our next article will look at the range, cost and fee structure of Section 12 J investments.
Note that the relative weightings of a core and satellite portfolio are key to the success of the strategy and should not be tackled without the help of a financial advisor.