In times of stress, the human impulse is to take action. When the economy and investment returns start to sink, this instinct could drive investors to do something - anything - just for the sake of taking action. This is precisely the wrong reaction in challenging times.
There are many knee-jerk short-term responses, all of which will ultimately detract from long-term investment returns:
Cutting exposure to risk assets
When the investment outlook and sentiment are poor, stressed investors often lose their tolerance for volatility.
The local equity market has now delivered a paltry annual return of 3% over the last three years. Local savers are not accustomed to so many years of anaemic, low-volatility returns. As a result, it appears that many investors are abandoning equities in favour of the yielding asset classes that have outperformed over this period. In contrast, we believe that fixed-rate bonds are overvalued, and that select equities offer more value than at any other time in the last five years.
It is crucial that investors maintain appropriate exposure to growth assets, which are the only investments that will provide the real long-term growth investors require. Despite the current depressed conditions, investment opportunities are still on offer. Even in a slow growth environment, great management teams can grow profits: either by gaining market share, expanding into other markets, exploiting new technologies or containing costs.
Investors should only make changes to their portfolio if their needs have changed, not in response to recent market movements or performance experience.
Shortening your time horizon
The temptation is to shorten your investment horizon - instead, it should be lengthened. Identify long-term winning managers and asset classes, and back them for the long run. Don't fidget or lose faith at precisely the wrong time. Staying the course has historically been the right choice, with strong performance recoveries after disappointing periods for local equities in 1997-1998, 2000, 2002, 2007-2008 and 2011.
Switching to cheaper products
In a low-return environment, investors typically consider cheaper managers or passive products to save on fees. However, this is precisely the time that outperforming the market becomes even more important. In a high-return environment, alpha is nice to have. When the market delivers 15%, itís nice to achieve an outperformance of 2% or 3%. But in a low-return environment, outperformance really starts to matter. Outperformance of 2% to 3% on a base of 9% is a must-have: The difference between 9% and 12%, compounded over years, can transform your retirement. Skill in delivering strong outperformance becomes more valuable (not less) in challenging times. Investing with managers that have a demonstrable track-record of successful asset allocation will become even more important.
Not maintaining strict discipline in retirement drawdowns
In a low-return environment, retirees should be very careful how much money they withdraw from their pensions. The gains from reducing annual drawdowns is non-linear. A small reduction in the drawdown rate can add years of additional retirement income. It is also important to understand the place of underwritten annuities in your retirement plan. In times of low returns, it is tempting to buy an underwritten annuity. But investors should be sure that the product is suitable to their needs. Be very careful of annuities that escalate by a rate below inflation. Currently, a 65-year-old investor typically gets a 4.7% yield in an underwritten annuity, which escalates at 5% a year. This may feel like a low-risk option, but in fact it is actually a proposition that holds a lot of risk. Over a 30-year time horizon, the power of compounding will not be on your side. In 30 years, something that costs R1 today will cost R4.3 at 5% inflation (compounded), compared to R5.70 at 6% and R10.10 at 8%. Inflation protection is crucial, and it would be prudent for investors to not consider anything less than an inflationary escalation.
Also keep the following in mind to make the most of your investment in a recession:
Ensure you are invested in the multi-asset funds with objectives aligned to your needs, then make time work for you. The vast majority of investors are better served by investing in funds that aim to deliver specific outcomes aligned to their specific needs, rather than funds with narrower objectives that limit investments to specific asset classes or market sectors. If investors have a clear understanding of their needs and invests appropriately, it is a lot easier to remain committed for the long term, especially in more turbulent times.
Consider committing the first R33 000 of your annual long-term investment programme to a tax-free investment into a suitably long-term orientated fund. Also consider opening tax-free investments for your minor children and grandchildren and give them the gift of compound growth.
If you are a high-income earner without a workplace pension fund, consider a once-off contribution (in addition to your normal contributions) to a retirement annuity fund.
History has taught us, time and time again, that our ability to forecast the immediate future is limited.
We continue to believe that equities will be the strongest weapon with which to beat inflation, and performing better than the market will be key.
Profile's Financial Markets 2014/15 is the companion volume to this website.
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