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Retirement Planning
Tuesday, April 1, 2008
Crisis assessment

The year has not started out the way many investors and retirement fund members would have liked. A combination of rising interest rates, high inflation, a volatile political climate, a potentially lengthy energy crisis and a slowdown in the world economy has many South Africans concerned about the value of their pension fund assets.

Seelan Gobalsamy, Executive Manager Old Mutual Corporate, comments, “We are facing what could prove to be the most difficult investment conditions in many years, what with highly uncertain local and global political and economic conditions and significant financial market volatility.
“Around the world this year, political changes and turbulence is making itself felt from the US and Russian presidential elections, Iraq, Iran, Pakistan, Chad and Kenya, to name but a few examples. Just as worrisome is the extent of the US growth slowdown, the global slowdown, the threats of stagflation and inflation, recent equity market sell-offs and continued fears in credit markets from the sub-prime crisis.”
In South Africa the situation is equally uncertain. Consumers are faced with higher inflation, rising interest rates, high debt levels and high oil and food prices. At the same time, financial markets are volatile and there is a risk that political developments will add to this during the year.
Investment returns are also deteriorating. Now that the long bull run in equities has slowed (the JSE returned just under 20% in 2007, about half of the returns of 2006), investors can not expect high returns for little risk. At the same time, more conservative investment solutions are starting to deliver lower returns, so investors are confronted with difficult choices regarding what to do with their investments.
The Old Mutual Investment Group (OMIGSA) expects it to be a tale of two halves for local and global financial markets and investors this year, with conditions tough during the first half of the year but markets beginning to factor in a better outlook for 2009 during the second half based on the positive impact of lower global interest rates.
Equity and listed property are again expected to outperform other asset classes during 2008 notwithstanding their volatile start to the year. Our longer-term view is that local equities will return between 10% and 13% a year as company earnings are supported by still-robust real economic growth of 4.5% (in 2008) to 5% (projected for 2009).
While the market isn’t likely to rebound straight away, conditions should start to improve in the second half of the year. A good deal of bad news has already been priced into equity markets, and in the next few months central bank action should help to revive key economies like the US. There should also be greater certainty surrounding the sub-prime crisis and the health of banks’ balance sheets. There are already some very attractive investment opportunities opening up on an individual share basis, particularly where there has been panic selling from offshore investors.

US Sub-prime crisis

The sub-prime crisis originated some years ago when record low US interest rates created a housing bull market. Financial institutions started offering mortgages to home buyers who would not normally have qualified for loans based on the institutions’ typical lending criteria. The institutions profited in the short-term from the higher loan rates they charged on these so-called sub-prime mortgages.
However, when US interest rates began to rise, along with fuel and food prices, many sub-prime borrowers could no longer afford to pay their bonds. As more and more properties were then put up for sale, house prices dropped and sub-prime lenders started making irretrievable losses. As a result, banks became wary of lending money and either started demanding higher interest rates to compensate for the perceived increase in risk or refused to lend money at all.
The sub-prime crisis became a global issue as there was less money in circulation - causing a worldwide credit crunch.

Energy crisis

Power is essential for any modern economy. A continued lack of power will affect growth of the economy, which will erode earnings generation, stock market potential and wealth creation. Certain key industries such as mining could be adversely affected in terms of production. This will have a negative effect on exports and the resultant foreign currency inflow. Many other developed economies have managed to deal with power crises in the past without it significantly impacting on economic growth.
Some experts estimate that the energy crisis may cut growth in South Africa by half a percentage point this year and deter foreign investment in South Africa. Lower growth means lower earnings for most companies. Lower earnings result in lower share prices, i.e. lower equity returns, which depending on your exposure to equities may negatively affect the value of your retirement savings, but not so much as to warrant investors to panic.
When it comes to the economy, uncertainty is never a good thing. An uncertain political landscape deters both foreign and local investment in a country. However, South Africa still has a strong democracy, solid fixed investment and a government in a strong financial position. Also, most of the political uncertainty has already been factored into local share prices.
The five-year outlook for the South African economy is therefore still positive, which underpins our equity market and should not negatively affect your retirement savings over the medium to long-term.

Retirement savings

Retirement fund trustees are obligated to seek investment vehicles that meet the needs of the general membership and generate favourable returns on your retirement savings without exposure to excessive risk. Current market conditions however are presenting significant volatility risk, with erratic returns being witnessed.
Comments Mr Gobalsamy, “For an individual member, this depends on your risk appetite and your investment time horizon. If you are close to retirement, exposure to current market volatility is a significant risk, which could adversely affect your retirement savings. This would occur if your retirement investment vehicle includes significant exposure to local and global equity markets with little or no capital protection, and you retire when the market is at a relative low level.
“On the other hand, members who are far from retirement may be well served by riding out this period of volatility and falling markets. Even with a high exposure to local and global equity markets, investments are expected to continue to generate more favourable returns in the medium- to long-term, with retirement savings recovering to favourable levels. Markets are known to display cyclical behaviour in this regard.” Notwithstanding this, retirement fund trustees are aware that some degree of protection is still valued by members regardless of the stage in their working lives, given the importance of saving for retirement.
“If your retirement fund is directly exposed to the market,” he says, “the extent of that exposure should be considered in line with your risk appetite. For example, if you are close to retirement, a high exposure to local and global equity markets could adversely affect your retirement savings in times like these, resulting in you having insufficient funds during your retirement. If your retirement fund provides the facility to make your own investment choices, it may be worth considering moving to a safe haven such as a guaranteed investment portfolio or cash, to mitigate this risk.
“Alternatively, a high exposure to equity markets may not be a concern if you do not expect to cash in your retirement savings in the near future.
“If your retirement savings are invested in a guaranteed investment product (such as a smoothed bonus fund), there is little need to consider cash to reduce exposure to volatile returns, as these products do specifically provide stable and secure returns, without limiting the scope for a equity market recovery.”
He adds that if you are risk averse or close to retirement and your retirement savings are invested in a market linked product, with significant exposure to equity markets, “it may be worth investing in cash for the improved security.”
However, your savings will lose out on any returns generated by an equity market recovery while they are not invested in equities. Cash is often regarded as a suitable investment in volatile times like these as it presents far lower risk of sudden and severe changes in value compared to equity markets. This, however, depends on whether your retirement fund provides the facility to make your own investment choices, as well as your appetite for risk. It also depends on your current retirement savings vehicle and what other options are available (i.e. whether cash portfolios are available as an alternative investment options.

Copyright © Insurance Times and Investments® Vol:21.3 1st April, 2008
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