by Tilman Friedrich
Investors in general and pension fund members more specifically will not be happy with the returns their investments have generated. Up to the end of December 2018, the average prudential balanced portfolio’s return of 7.7% has barely outperformed inflation of 5.2% and has just managed to match the money market return of 7.5% over a 5 year period but fell far short of both the money market return and its long-term performance objective over any shorter periods. It only really managed to achieve its long-term objective of inflation plus 5.5%, before fees, over 10 years and longer.
Now consider the same parameters to the end of January 2019 where the average prudential balanced portfolio’s return of 8.0% represents a slightly improved the outperformance inflation of 5.2% and of the money market return of 7.5% over a 5 year period but still falling far short of both the money market portfolio and its long-term performance objective over all shorter periods, once again only really managing to achieve its long-term objective of inflation plus 5.5% over 10 years and longer.
Finally let’s move the goal post by another month to the end of February 2019. Now the average prudential balanced portfolio’s return of 8.2% represents a slightly improved outperformance of inflation of 5.1% and of the money market return of 7.6% over a 5 year period but still falling far short of both the money market portfolio and its long-term performance objective over any shorter periods. It only managed to achieve its long-term objective of inflation plus 5.5% over 10 years and longer.
What this does show is that fortunes for the more volatile and higher risk prudential balanced portfolios turn rather rapidly and adding two months of positive, just slightly positive returns, add the end of the period and taking off 2 months at the start of the 5 year period can make quite a difference to the end result. We added a cumulative 4% for January and February 2019 and dropped a cumulative 1.5% for January and February 2014.
Can we look forward to the results of the first two months of 2019 signifying a turnaround of the fortunes of equities? Certainly as far as local equities are concerned, they have been far behind the curve in terms of medium term actual yields versus long-term yield expectations. Since the beginning of 1987 the real return was a mediocre 5.8% including dividends – that’s over the past 32 years! Compare this to the S&P 500’s 6.6% real return over the same 32 year period where one would expect the risk premium to require local equities to produce a higher return than US equities. Compare local equities 32 year return also with long term (116 years) returns of around 7.5% for SA equities and 6.5% for US equities. Of course this is not the only consideration. It is common cause that current low returns are the result of central bank intervention in the markets since the financial crisis and that we are currently en route to a normalization of monetary policy.
In the US, the Fed rate currently represents a real return of 1%, which at times has been negative, so at least a bit of normalization although the gap needs to open up further to around 2% in order to get back to its long-term average. Markets tend to factor in the future to the extent it is reasonably foreseeable, so it is likely that at least some further normalization has already been factored in that is still due to come about. US inflation currently shows a clear downward trend which means that the gap will be opened up as the result of declining inflation, where it was already down to 1.2% recently but has picked up a bit to 1.5% of late.
Our concern is thus not so much that equities may not meet their long-term return expectations going forward. Our concern is much more that pension fund investment returns are diluted ever more by what we have been referring to as a serious onslaught on the pensions industry that seems to be considered a duck that lays the golden egg. Consider the ever increasing cost as a result of increasing regulatory and governance requirements. Consider fiscal and monetary objectives of healing all sorts of ailments government and our national economy are experiencing where pension fund assets are forced into unlisted investments and where the local investment allocation will soon reach 45%, higher caps having been mooted already.
In our commentary in the September column of this investment brief, we speculated that the investment regulations will result in pension funds’ equity allocation effectively being capped at 60% as opposed to an implicit allocation of 75% that the current typical pension fund model presupposes. This will dilute expected long-term pension fund returns down form 6.3% to 4.6% before fees. After fees we will thus be looking at a net return of below 4% per annum whereas the pension model requires 5.5%.
We believe that this is a very unfortunate development pension fund members are facing without them being able to do much about it. It seems our government finances are under so much pressure that short-term survival rather than long-term planning defines government policies, to our own detriment. South Africa scores only 52 points on the Melbourne Mercer global pensions index, putting it into the 3rd lowest of 7 categories, where the highest ranked country is Netherlands with a score of more than 80. Namibia will be below SA by some margin just on the basis of our old age grant being quite inferior to that of SA and we are likely to move down further as declining pension fund investment returns will further dilute the overall adequacy of our pension system. The direction should be the opposite and should be driven by supportive national policies. It does not seem we have the means for such policies. What does this mean for Namibia’s future credit rating?
What can a pension fund member do about this dilemma? Well the majority of members, particularly on the lower half of the income spectrum will not be able to do anything about this, as they will not be able to afford any other savings. They will have to hope that government will be able to look after them once they have retired and do not have the means of their own to do so. On the upper half of the income spectrum, savers can and must apply their total discretionary capital to make up the effect of declining pension fund investment returns. Unfortunately this will not be possible through investment in Namibia as every conventional savings mechanism is subject to the same or similar dilution. It is common cause that equities are an essential component of every investment strategy and are really the only asset class that offers the opportunity to make good the shortfall experienced on pension investments in Namibia. Consequently investors need to use every opportunity to expatriate their discretionary capital to invest primarily in foreign equities.
Unfortunately the Rand is currently substantially undervalued at around 14.3 to the US Dollar and should be closer to 12. It is thus not a good time to expatriate discretionary capital right now. It is perhaps not a bad idea then to keep this capital in the money market, while it returns a real rate of about 2% p.a., in anticipation of an opportunity to expatriate the capital. As far as our knowledge goes, approved expatriation applications are valid for 6 months. Typically obtaining approval to transfer money offshore is quite a constraining factor, where timing will be crucial, and perhaps one should ensure that one has the approval in your pocket and renew if an opportunity does not arise within the next 6 months.
Important notice and disclaimer
This article summarises the understanding, observation and notes of the author and lays no claim on accuracy, correctness or completeness. Retirement Fund Solutions Namibia (Pty) Ltd does not accept any liability for the content of this contribution and no decision should be taken on the basis of the information contained herein before having confirmed the detail with the relevant party. Any views expressed herein are those of the author and not necessarily those of Retirement Fund Solutions.