Too little risk

Too little risk

Broadly speaking, there are 2 things that impact the return of an investment over time. They are:

  • Asset allocation, and
  • Fees

When it comes to the retirement space, government seems hell-bent on targeting the issue of fees but does not appear to have given much thought to the issue of asset allocation and its role in returns. It is my contention that if the current format and implementation of regulation 28 of the pension fund act remains in place, we will be complicit in a significant cause of people under-funding their retirement. If you don’t believe me, consider the following.

As a result of the very strict application of regulation 28, most money that is going into RA’s and pension funds seems to be going into the good old “balanced” or managed funds. These funds typically can invest up to 75% of their assets in equities and up to 25% in property. They can also invest up to 25% offshore. Sounds perfect; except for the fact that despite most of the investors in these funds having (very) long time horizons, for some peculiar reason, these funds tend to be managed with a 5-7 year time horizon.

As a result, they tend to have much less than 75% in equities (typically around 60-65%) and at most, around 10% in property. The result of this is that over time, they can be counted on to deliver returns of around CPI+5% which is not bad but not as good as it could be. If the industry was serious about investors funding their retirement, then they would offer a more “aggressive” option and would strongly encourage (younger) investors to use this. There is nothing in the legislation that stops a fund offering a retirement “growth” or CPI+7-8% portfolio. This could be done by constructing a portfolio with 75% in equities and 25% in property (with 25% of the fund offshore as well). I don’t have the resources to do any significant back testing or anything like that but it is my belief that while this portfolio may be more volatile than a managed fund, it would deliver significantly better returns over a retirement funding cycle.

Considering that most people fund their retirement through their pension fund or retirement annuity and that this is done on a monthly basis via a debit order, investors would benefit from the rand-cost-averaging that any volatility might present. The end results, however, in my opinion, far outweigh any concerns about volatility and it is my belief that it would also present great opportunities for financial planners (and the industry as a whole) to help investors manage their emotions around money and to ultimately take a long-term view of investing.

Consider the following example by way of illustration of the long term effect of an asset allocation that is too conservative:

  • R1000 pm (escalation at CPI) and achieving a return of CPI+5% over a 40 year period should yield a final value of around R15.7million.
  • The same debit order compounding at CPI+7% over the 40 year period should give around R27.1million.
  • As little as a 2% difference in the return compounded over 40 years results in almost double the amount of money at the end of the period and is able to generate 72% more income as a result*.
Debit order of R1000 (esc at 6%pa)

11% (+5%)

13 (+7%)

Final Value

R 15 757 238

R 27 103 110

Probable income (today’s value)




Is anyone at the regulator/national treasury listening? Is there anyone out there who is prepared to do the back testing and then is there anyone who is prepared to offer retirement investors a better deal? I have a heap of money that is looking for this option.

Note: I don’t have the stats to back it up but I also suspect that most retirement portfolios are sitting with far too much money in cash because investors and retirement fund trustees don’t actually understand risk. Why else would 25-45 year old investors sit in a retirement portfolio with less than 50% in equities?