RYK VAN NIEKERK: World markets have been extremely volatile over the past few months. The S&P 500, for example, fell by nearly 35% from mid-February to March 23, then rebounded strongly and is currently around 3% higher than the lows seen in March. For most investors, this is a nightmare, especially if you have retired or are close to retirement. And during such volatile times, there is always much emotion in the air. But investors should be very, very aware that any emotive decisions may have a dire impact on future retirement funds.
Marc Lindley – he’s the sales manager for strategic alliances at Ninety One – joins me now. Marc, how does this volatility compare to the volatility we saw during the global financial crisis way back in 2008?
MARC LINDLEY: Hi Ryk, thanks for having me. Very happy to be here. I think the magnitude of the falls in short periods of time probably wasn’t quite as extreme as what we’ve seen recently. But I think what we saw then that we could possibly see this time around as well is that while the recovery’s been rapid, as you say, only time will actually tell whether any of these recoveries can proceed for an extended period of time or whether we might see other periods of volatility like we saw in 2008.
RYK VAN NIEKERK: But people who are close to retiring or who have retired are always very, very nervous and anxious when we see volatility like this, especially on its way down. But you have analysed the data of the 2008 crash due to the global financial crisis. And you formulated three scenarios, which I think pensioners would find very, very interesting. Can you discuss the assumptions you made for those scenarios and what the findings were?
MARC LINDLEY: Yes, absolutely. So firstly, the cause for the work was we wanted to try and demonstrate the importance of holding your nerve and sticking with a plan during times like these. Because I think if you and your financial advisor came up with a correct plan at the outset, then that should be good enough to carry you through both good and bad times. Therefore, it shouldn’t need a huge changes when you experience periods of volatility. So what we did was we basically looked at an investor who retired at the beginning of 2007, and that was the year in which the global financial crisis began.
They invested R5 million into a living annuity and they were drawing a 5% income. And the rand value of that income escalated by inflation, every year. So we used the Ninety One Opportunity Fund as a starting point for the investment in all three scenarios. And that was used as a proxy for the multi-asset high equity sector, which is where most retirees would find their assets invested. So then, when the market actually crashed, we looked at three courses of action that the pensioner could have taken after that market drop.
Three courses of action
- The first one was that the client would decide to remain invested in the fund for the entire period.
- [In] the second, the client switched out of the fund and into cash and then they remained there; basically that’s a client that doesn’t believe that the market will ever recover from those levels.
- And then thirdly, the client switched out of the fund into cash and then they tried to be a bit more clever and they tried to time the markets by switching back into the fund a year after the market bottom. So they sat in cash for a year.
RYK VAN NIEKERK: And the findings are very, very interesting. Can you take us through those?
MARC LINDLEY: Yeah, absolutely. I think the results were actually staggering and they probably even exceeded our expectations, to be honest.
If you look at the first scenario, where the client stayed invested: their final portfolio value at the end of March that year would have been R8 million wrapped, and their lost income drawn would have been just 5.5% of their capital value. In other words, after 13 years, they had increased their capital value by R3 million.
But I think the more important stat for me is that the income that they were drawing was barely higher than what it was when they started. And I think that’s really key to sustaining income throughout retirement. And I think what makes the outcome more impressive is the fact that it actually takes into account not only the drawdowns that were experienced in 2008 but also the recent crash that we’ve seen, a bigger [one] in March.
Whereas if we look at the second scenario, where the client made that permanent switch to cash, this client wasn’t quite so fortunate. Their end value would have been only R3.7 million. In other words, less than half the net [of those] that stayed invested. But I think critically, if you look at the end of the illustration, their income draw would have reached nearly 12% of their capital value and that’s just not sustainable.
And in the final scenario, where the investor tried to time the market: they would have done better than if they’d made that permanent switch to cash. They would have still given up more than 25% of their portfolio’s capital value relative to if they had stayed invested, and their end value would have been R5.8 million. So they’ve given up more than R2 million in capital, and their income draw would have been 7.6% of the capital value. So that’s starting to get to the sort of level where you might have to worry a little bit and start looking at other areas of funding your income.
RYK VAN NIEKERK: But this is not intuitive.
The first scenario, you do absolutely nothing and you are better off than both the other scenarios – but also significantly better off.
You’ve actually gained R3 million in new capital and you draw down significantly less as a consequence. Do you think when pensioners see the market fall like we’ve seen it fall in March, that they think, oh, just don’t worry, we’ll sit on our hands and we’ll have a better outcome at the end of it? It just doesn’t seem intuitive.
MARC LINDLEY: Yeah, I think it’s very hard to do nothing when you see the world falling apart around you. But I think for pensioners, especially, holding that discipline of sticking with the plan, becomes much more difficult because, for a lot of these people, their retirement savings are basically all they have. So, therefore, it’s logical to think that if I switch into cash, I can at least protect that value. But I think the issue is that the returns that you’re getting from cash now after the 200 basis point rate cuts that we’ve had recently are 4.25% basically now, for the repo rate.
So if you’ve experienced a 10% drawdown, that would take you two and a half years just to recover those losses that you’ve actually made. And now on top of that, you’re drawing an income which, remember, we said, was 5%. So it’s more than the cash return that you’re gradually getting from cash. So it’s impossible for you to do anything other than erode your value over time. And then there’s another impact on top of that, which is the impact of inflation.
So all the goods that you’re buying, things like your petrol, your healthcare and your energy are escalating by a lot more than the return of cash. So whilst it is intuitive, effectively, what you end up doing is you end up preserving capital value that’s fallen quite significantly. And now you’re essentially drawing the same amount of income in rand terms, but from a much lower capital base, which makes your chances of recovery very, very small.
RYK VAN NIEKERK: So the central message is don’t change anything in volatile times. Don’t try and preserve capital or prevent capital losses. The market will take care of itself.
MARC LINDLEY: Yeah. We’ve done other work around this as well. A good article by one of my colleagues that highlighted several different crashes. I mean, we’ve just looked at one here, which is 2008. But investor behaviour time and time again, clients typically switch out of risk assets at the worst possible time and then they switch back in far too late. They sit on the sidelines for too long. So whilst the falls in markets can be pretty scary when they actually happen, the recoveries like you highlighted in the introduction, can be equally strong and happen very, very quickly.
And it’s important to be positioned in those assets so that you can benefit from those moves when they happen. And then there’s a lot of work that’s been done around missing the best days of market returns, and no one knows when those days are actually going to happen. But the important thing is actually being positioned in the right place so you can benefit when that does take place.
RYK VAN NIEKERK: Whose responsibility is the asset allocation? Is it the pensioner, [their] financial advisor, or the asset manager’s responsibility?
MARC LINDLEY: Depending on the approach that’s taken when that financial plan is put together, it could be any of those, to be honest. I think if the pensioner has a financial advisor, then that’s a decision that they would be outsourcing to their financial advisor. But the fund that I was talking about earlier, the Ninety One Opportunity Fund, that’s a multi-asset high equity fund where the asset manager themselves, the portfolio manager, would be responsible for making the decisions as to how much they allocate to cash, how much they allocate to fixed income, equities and offshore, etc. So they would try and do that balancing act that’s needed for the pensioners to ensure that they’ve got enough exposure to growth assets and offshore, for example, so that they can hedge against inflation, but also enough defensive assets to ensure that you don’t give all of that growth away when there’s a market correction.
RYK VAN NIEKERK: You’ve discussed those scenarios, I just want to return to those because I find it very interesting. How many pensioners actually do react and try to preserve capital and move money to cash. Is that a common theme? Do you still see it? Because there seems to be a big message here: Listen, don’t do anything.
MARC LINDLEY: Yes. Unfortunately, it’s something that we see and we saw a lot of switches that took place around March 23, around whether the market actually bottomed at the time and unfortunately those clients haven’t been able to participate in the recovery that’s happened subsequently. I think that’s really why we’re highlighting this body of work that we’ve done now, because there may be periods of volatility that follow now as information around corporate earnings and those sorts of things come to the fore. And if the market dips again, we will try and discourage clients from repeating that same behaviour because it’s not in their long-term interest to do so.
RYK VAN NIEKERK: Just lastly, are you seeing pensioners actually also trying to move money from living annuities to, say, a new guaranteed annuity?
MARC LINDLEY: That conversation has definitely come to the fore because, with the volatility that happened, we saw big spikes in long-term bond yields, and the rates that guaranteed annuities provide are typically linked to the long end of the bond yield curve. So that did happen and we definitely saw some similar interest or an increase in interest around guaranteed annuities. But since the government intervention, we’ve seen that stabilise somewhat. And you’ve already seen quite a big drop in the rates available from guaranteed annuities, which would suggest to me that if you hadn’t made that move already, you’ve probably missed those best opportunities that exist there.
I think there’s a couple of other important points that I would raise around guaranteed annuities. And essentially, as I say, it’s linked to the long end of the bond market. So when you’ve got a guaranteed annuity or you’re buying a fixed income portfolio and our expectation, as per long-term data, is that growth assets should outperform fixed income over the long term.
And I think it’s also important to consider what you give up when you have a guaranteed annuity, and that’s your right to your capital. You compromise that in exchange for income for life. But what the mortality pooling means is that the clients who die sooner than expected actually end up cross-subsidising the income for those that live longer than expected.
And I think the other thing that must be considered in this discussion is that once you’ve made that call to switch from a living annuity to a guaranteed annuity, you can’t reverse that decision. So it’s got to be considered very, very carefully. And the value of your savings at the time that you enter that guaranteed annuity will determine your income for the rest of your life.
So, therefore, again, intuitively, if you switch to a guarantee after a crash, you’re essentially locked in that loss and it means you can’t ever recover that value.
RYK VAN NIEKERK: Interesting indeed. Marc, thank you so much for your time today. That was Marc Lindley. He is the sales manager for strategic alliances at Ninety One.
Brought to you by Ninety One.