With lower total returns expected across all asset classes for the next three to five years and people living in retirement far longer, investors looking for inflation-beating returns would be wise to consider allocating a higher proportion of their savings to growth assets, like equities.
This is the cautionary message from Old Mutual Investment Group South Africa portfolio manager Peter Brooke, who heads the Macro Strategy Investments boutique.
Commenting on future investment returns, Brooke says he expects local equities to generate total returns of between 10% and 13% a year over the next three to five years as corporate earnings growth slows — far lower than the heady returns recorded in the past few years.
“Equities should remain the best-performing asset class, although listed property still has good growth prospects with a total return of around 10% a year over the medium term. Bonds, on the other hand, having adjusted to the lower inflation environment, have a performance potential of about 8% a year over the period. This is only slightly more than cash, which is expected to deliver about 7% a year,” he notes.
“If you consider that we are forecasting average inflation of around 5% over the medium term, the real returns from all asset classes going forward will be considerably lower than those seen in the past four years.
“At the same time, longevity statistics show that the probability of an individual aged 60 surviving to age 90 has risen from 16% in the 1980s to 36% today. The combination of these trends dictates that those people who haven’t been saving or building up assets to date will be forced to save even more going forward to have enough for retirement.”
Apart from saving more, these trends also make a strong case for increasing one’s investment exposure to higher-growth real assets like equities both before and during retirement, says Brooke. Growth assets preserve an investor’s capital base longer into retirement because of the higher returns they offer.
Although individuals have been avoiding holding equity in their retirement portfolios because of its short-term volatility and the greater risk of capital loss, a long-term approach is key, he points out.
“If you hold equity investments for 10 years, the probability of recording negative returns reduces substantially through the principle of time diversification of risk. With today’s longer life spans, investors are able to take advantage of this. Equally, investment risk can be lowered through asset class diversification.”
He advises investors to adopt a long-term investment horizon, lower their return expectations and consider flexible asset allocation funds that can deliver solid returns over inflation as a smart option.
“These funds not only offer important diversification benefits, but their equity exposure can also provide the additional performance necessary to beat inflation while also targeting specific risk levels. For example, our range of asset allocation funds targets returns of between 3% and 7% over consumer price inflation, depending on the level of risk.”
Meanwhile, Grant Pote, Old Mutual’s executive sponsor for retirement-fund reform, says the government’s recently proposed reforms to the country’s social security and retirement savings systems are critical in helping address the savings crisis affecting many South African households.
“We believe the reforms will improve household savings, boost economic growth and improve income security for a far larger percentage of the South African population, while also reducing the cost of saving and improving access to formal savings vehicles,” he says.
“Given the key imperatives of increasing access to retirement savings for all at low cost, we believe tat this can best be achieved with least risk by taking advantage of the existing private sector infrastructure. This needs to be supported by enabling regulation, such as introducing compulsory provisioning at an appropriate percentage of salary for all formally employed individuals.”