Two savers contributed R10 000 a month, increasing by 4.5% a year, towards retirement from April 2007 and made no early withdrawals. In both cases, their respective funds targeted returns of at least CPI plus 5% a year, a standard benchmark for retirement planning.
But in March 2020, one saver had 27% more money than the other: R3.95 million versus R3.11 million.
Both retired that month, based on their ages and mandatory retirement dates – just as markets crashed because of the Covid-19 pandemic.
Retirement incomes
Yet their retirement incomes diverged dramatically.
In the first example, assuming the same annuity rates, one retiree earned R10 000 a month from a life annuity, while the other received R7 300.
“Someone is materially impacted; they are taking a nearly 30% haircut on their standard of living,” said Marvin Nair, investment solutions executive at Old Mutual Corporate. He was speaking at the recent Institute of Retirement Funds Africa (Irfa) conference.
These examples are based on:
- Old Mutual’s Absolute Growth Portfolios (AGP) Smooth flagship product, which was launched in April 2007; compared with
- The Alexforbes Global Large Manager Watch Survey ‘Best Investment View’ median fund return.
While saving for retirement would be longer than 13 years, Nair intentionally used that time horizon since it coincides with actual data he had based on the Old Mutual AGP Smooth product 2007 launch.
In addition, retirement dates are largely determined by when people are born – and as Nair said: “None of us picked our birthdays.”
Retirement during a market crash
But retiring during a market crash can have lasting consequences for the income they receive for the rest of their lives.
This is known as sequence-of-returns risk: the order in which investment returns occur can have a significant impact on retirement outcomes once withdrawals begin.
Members invested in market-linked balanced funds, which typically hold bonds, equities and listed property, can suffer a substantial loss of capital when markets fall just as they retire.
Money received over a longer period
A second example shows how sequence-of-returns risk can affect retirees over a longer period.
Two investors each started with R5 million in 2007 and used a living annuity, which pays an income until the invested capital is depleted. Both withdrew R30 000 a month, increasing by 4.5% a year.
After 19 years, the investor in the risk-managed solution had R11.5 million remaining, compared with R3.7 million for the investor in the non-risk-managed portfolio.
“These are massively different outcomes,” said Nair, noting a difference of more than 200%.
The investor with R3.7 million risks running out of money during their lifetime, which “isn’t a good outcome”.
Smoothing out the shocks
Nair explained that in a smoothed bonus product, the insurer invests in a similar mix of underlying assets to a typical balanced fund, but instead of passing through the raw market return, it declares periodic bonuses (monthly or annually) based on the size of a reserve.
Some returns are held back during strong markets and used to support bonuses during weaker periods.
“The goal is to reduce the bumpy ride,” Nair said.
But Gryphon Asset Management portfolio manager Casparus Treurnicht said financial markets only go through brief moments of “lows”.
In fact, 65% of the time the market moves up, he said.
Total-return data
Using total-return data from the JSE All Share Index and the MSCI World Index from 1998 to 2026, Treurnicht was able to show that the equity market goes up in 65% of those years.
“Why would anyone want to focus on the 35% likelihood of lows with a smoothed bonus product, that also reduces or smooths out 65% of the highs?” Treurnicht asked.
“It makes no sense to me.”
Nair’s counterargument is that market-linked investments “could give you a better outcome during good periods, but a terrible outcome in bad periods”.
“A smoothed bonus portfolio gives a better average outcome to all members.”
Balancing growth and protection
Nair advocates risk-managed solutions, including hedge funds and strategies that manage risk outside capital markets.
Modern smoothed-bonus products can also offer percentage-of-fund-value guarantees. Using AGP Stable as an example, Nair said an 80% guarantee means that an investor with R100 invested would not receive less than R80 at a benefit event such as retirement or a living annuity drawdown.
If the R100 grows to R200, the investor would not receive less than R160 at a benefit event.
Nair argued that “because members don’t know if their retirement will coincide with a market crash, smoothed bonus provides them with the ability to have growth asset exposure right up to and beyond retirement, while reducing the impact of a market downturn taking place in the month they retire or draw an income”.
Younger savers
David Shapiro, chief global equity strategist at Otto1890, said smoothed-bonus products do not provide protection for free.
“I suppose the further away you are from retirement, the less you need the smoothing,” said Shapiro.
“This means for younger savers the plan is not as appealing as for those investors close to retirement who might want to avoid the consequences of a catastrophic fall in the market.”
The next intense event
“We don’t know when the next intense market event is going to take place,” said Nair at the Irfa event.
“Is it an AI bubble? Is it going to pop?
“We don’t know.”
“But we really should be protecting members so that if it does pop when they’re retiring, we are not obliterating the money that they are trying to draw an income from into the future.”
This article was republished from Moneyweb. Read the original here.