Investment Newsletter (and related info) 10/2009

Your ten retirement tips for 2010

We have reached the end of another challenging year in the investment and retirement fund industry. 2009 started with global financialmarkets in freefall and the entire financial system in crisis. In an attempt to stem the flow and avert a second 'great depression', the world's leading central banks responded with now well-documented stimulatory measures. By March 2009 markets reached the point of maximum pessimism - and then everything changed as markets bounced back sharply.

For those planning for retirement or already in retirement, the changed environment presents a number of challenges. Below is a list of 10 retirement issues to consider during your year-end break.

1. Don't assess a manager's performance over the short term (1-year)
If you assess your manager's performance over 1 year, expect to chase your tail. Short-term returns are incontrovertibly random. It is statistically unlikely that an asset manager will not have a good year in a 5-year period - all managers have good and bad years. However, when you assess performance over meaningful periods (5 or 10 years) you'll find only a handful of managers who consistently deliver.

2. Headline inflation is not necessarily applicable to all South Africans
A looming crisis in the retirement industry is how we view inflation. Headline inflation, as is quoted in the media, is based on an 'average' South African's basket of goods. For those individuals who fall within the LSM 8, 9 and 10 grouping, there is a disproportionate exposure to healthcare, municipal rates, water and electricity - all of which we know increase annually by a rate far above that of the quoted headline inflation. What this means is that a retired person in this grouping is more likely to experience inflation of up to 10% as opposed to the average South African who currently experiences inflation of around 6%. Inflation is high and often it's higher than we think. One therefore needs to be mindful of this when we do any retirement planning.

3. Expect to live longer
Advances in healthcare technology and improvements in nutrition, means that people are living longer and therefore life expectancy is increasing. A person retiring at age 60 today, can generally expect to live up to his/her mid 80s. Life expectancy is way ahead of where it was 20 to 30 years ago and needs to be considered when planning for retirement.

4. The need for exposure to growth assets is high
When you retire at age 60, the first ten years of retirement is bound to be financially comfortable. This sense of comfort could however be short-lived. As you move into the next ten to fifteen years you may realise that you've been left vulnerable, either from excessive draw-downs on your capital or insufficient exposure to growth assets in the early years of retirement. The two graphs in Figure 5 below illustrate a fairly extreme situation, clearly showing the impact of insufficient exposure to growth assets and a high drawdown rate over the long term.

5. Avoid anchoring off the recent past
Investors tend to base their decisions on recent experiences - this is called anchoring. A good example of how we anchor is the rand. Without exception, they have predicted the rand to weaken by 3% per annum. It almost doesn't matter if the rand had halved; economists simply adjust to a new level and set their expectations from there. The housing market is another good example where anchoring takes place. Over the past eight years house prices in South Africa have practically tripled. It may be difficult to believe, but a house that is in the market for R2 million today, would have probably fetched around R600 000 in 2001. How many of us were keen to buy a house eight years ago? Or who wanted to get into the buy-to-let market?
The reality is that not many of us did because we adjust to the price levels of the day almost regardless of whether or not the levels are high or low. In the world of investments one has to understand where prices have gone and therefore whether that asset presents value or not.

6. Don't underestimate the importance of asset allocation
One of the big trends we see in the unit trust industry is that people are moving out of building block funds into asset allocation funds,
where the asset manager is empowered to make the asset allocation decision on their behalf. To illustrate how the asset allocation decision can dwarf the security selection decision in one's portfolio, consider the following example: Had your money been invested in the Coronation Top 20 Fund at inception in October 2000, you would've made a fantastic investment as this fund has compounded at 8% p.a. since inception.
However, had only 20% of your capital been invested in this fund, you would have fared far worse than an investor with 50% of his capital in equities over a period in which the All Share Index was up 3.5 times, even if they were invested in the worst performing equity fund.

7. Are you thinking enough about tax?
While it may have been inconceivable three years ago, most developed countries are now running budget deficits in excess of 10%. What this means is that the central banks' exit strategies are likely to comprise of an ugly cocktail - higher taxes, lower government spending and higher interest rates. High-earning residents in the UK are already exposed to higher tax rates, keeping only 36 cents per pound earned after income and NHS taxes. In South Africa we should prepare ourselves for the possibility of higher taxes. We believe that an increase in the capital gains tax rate is one potential response to pressure on Government revenue.

The following example illustrates the damage higher tax rates could do to South African savers:

Consider two investors who invest in the same unit trust fund over a period of 20 years. Investor one leaves his capital in the same fund and only disinvests at the end of the 20-year period. Investor two, however, crystallises his gains each year and as a result is subject to capital gains tax. Over the investment period, investor two leaks 15% of his capital, or 27% should Government decide to double his tax rate from 10% to 20%. To avoid this leakage, we believe investors will increasingly be forced to find a manager that they can back over the long term and stay invested in the funds they are in from the start.

8. Markets are efficient discounting mechanisms
Shares were spectacularly cheap at the start of the year as they were pricing in financial Armageddon. As a result, risk assets represented the third best buy in 150 years during the first quarter of 2009. However, many investors (quite sadly) missed the rally as they were sitting in cash. Investors should remember that markets are efficient discounting mechanisms. When the newsflow is poor, this will already be reflected in the share price: it is in fact the time to be buying assets. Similarly, when the SA economy has performed very well and newsflow is good, markets will reflect the environment in the share prices, and this will often be the time to be selling assets.

9. Use the strong rand to balance your portfolio
In the last quarter of 2001 the rand weakened by 32% (it closed the year at 11.90/$). Panic ensued and money poured into offshore
unit trusts until virtually every fund in the country had reached its capacity. From that point on the rand strengthened steadily, all the
way to 5.60/$ in December of 2004. We can think of no better example of how 'the man in the street' inevitably buys high (in this case when the rand had already weakened) and sells low (when the rand is strong). Since that crazy summer of 2001, offshore funds have experienced steady outflows as investors brought back the capital that they so hastily externalised.

While the rand may remain strong in the short term, we believe that the risks are heavily skewed to the downside. Industrial South Africa is not competitive at these levels. This is unlikely to change with electricity prices set to increase substantially over the next few years and wage settlements to be in the high single digits. Investors were desperate to go offshore when the rand was weak (prices were high). Today the rand is strong (prices are low) and appetite appears to be non-existent. We think this is a big mistake.

Studies on optimal portfolios recommend a 20%-30% offshore allocation through the cycle. With the rand strong and better value offshore we think investors should be at the high end of that range. Don't wait for the rand to weaken before you move.

10. Buy global equities
It seems that South Africans have been so scarred by their recent experiences (anchoring) that they are determined to avoid offshore investments, regardless of the merits of investing offshore. Offshore investments diversify a balanced portfolio and offer an opportunity to increase return and reduce risk. South Africa represents 1% of global GDP. It is a commodity-heavy country on the southern tip of Africa. The opportunity set offshore is greater with industries that don't exist locally, such as IT, electronics and pharmaceuticals. The world is changing - emerging markets are driving the global economy as they industrialise and urbanise. This will create wealth for investors prepared to take a long-term view and invest in those regions. We believe global equities currently present more value than any other asset class.

Courtesy: Coronation Fund Managers www.coronation.com