2017 The Income And Growth Challenge - September 2017
Investing In Retirement- September 2017
RETIREMENT INCOME OPTIONS
Most retirement savers consider two options when it comes to purchasing a compulsory post-retirement income: a traditional guaranteed annuity or a living annuity (see Figure 1).
According to the 2016 Living Annuities Survey released by the Association for Savings and Investment South Africa (ASISA), South Africans have some R333 billion invested in living annuities. While living annuities provide the benefits of flexibility and heritability, and are often the most appropriate retirement income solution, they expose investors to capital market and longevity risks.
Living annuities need to be managed on an ongoing basis in an appropriate manner. Sadly, they are often bought for the wrong reason. Investors with insufficient retirement capital may find the potential of drawing a higher initial income (relative to a guaranteed annuity) attractive in helping to maintain a certain lifestyle in the early years of retirement. But hardship will follow if the capital underpinning their pension is depleted. This scenario will play out if the income drawdown rate significantly exceeds the investment growth, especially during the first decade after retirement.
>> FIGURE 1: CURRENT COMPULSORY POST-RETIREMENT INCOME OPTIONS
TOUGH INVESTMENT CLIMATE FOR RETIREES
After a relatively benign period, investment returns have been disappointing in recent times. Equities (shares) in particular have not delivered any real growth.
>> FIGURE 2: FALTERING MARKET RETURNS
While equities are more volatile and risky, traditionally they deliver the best growth over time. Over the past three years, however, investors in living annuities with a strong equity exposure have seen disappointing returns. Even over the past ten years, their outcomes have been relatively weak, with very little reward for the investment risk taken.
In fact, these investors would have achieved very similar returns regardless of whether they were invested in managed income funds, income-and-growth or even balanced funds – which all have very different levels of equity exposures – over the past decade.
This has been very frustrating for investors. Many have started to shift away from underlying unit trusts with larger exposures to equities and towards those with more fixed income investments like bonds, which have delivered similar returns at lower historical risk. This is evident from Figure 3, which shows that fixed income funds have enjoyed a substantial share of inflows, while large amounts flowed out of income and growth funds (lower-equity multi-asset funds).
This is concerning. We believe that equities will deliver the strongest investment growth over time, and provide the most reliable hedge against inflation. Retirees who do not have enough exposure to these growth assets may risk an erosion of their savings.
It is important to point out the context of the disappointing returns over the past ten years (to end-July 2017). At the start of the period in 2007, domestic and global equity markets were still elevated before the global financial crisis would wipe out 44% of the value of SA equities. The end point coincides with an extended period of stock market malaise in SA amid domestic uncertainty. This has had a distorting impact on the returns. The peculiarities of this window of time will not necessarily repeat and do not violate the fundamental principles supporting the expectation that equities will outperform over the long term. Given the anomaly of the measurement period, as well as the more attractive valuations we are seeing in local equities (explored on page 11), it is not unreasonable to expect future returns that are in line with long-term averages.
Equities have been the long-term driver of growth in retirement capital for almost a century, as is evident from Figure 4. For retirees, judicious exposure to growth assets is crucial.