Evidence that your portfolio is working as expected is far more valuable than hearing that none of this volatility will matter in the long run. That is scant comfort to anyone who has seen their modest investment gains, accumulated over the last however many years, wiped out in a matter of days. It also won’t fill them with confidence that a high equity fund is the way to go, or that they aren’t better off earning lower but more secure returns in a money market fund. That approach would have returned only marginally less over the past ten years, but without all the stock market anxiety.
If nothing else, investors should be reassured at this time – when so many calamities have come together in one toxic mix – that they are shielded from the worst of the market fall-out, and that their pension would have been safe, even if retirement was just around the corner.
Diversification is working
In the financial world, it’s the stock market that grabs the headlines, so much so that you might believe that your fund value depends entirely on how well the JSE is doing. Which, last month, was not great. At one point it was 36% off for the year, 25% down in one week, anticipating the fiscal and economic fallout from the pandemic.
Fortunately, it is not just about the JSE, though. Most retirement portfolios hold a variety of investments, which all react differently to the news cycle. A typical balanced high equity portfolio (the norm for most retirement savers) will invest 25% to 30% offshore, mainly in foreign shares, providing exposure to different currencies, economies and sectors. The likes of Amazon, Alphabet (Google), Apple and Netflix may not be listed in South Africa, but you probably own a piece of these companies anyway, through your fund’s offshore allocation.
Apart from gaining exposure to high-growth industries elsewhere, local investors also benefit from the rand weakness that usually attends a global market crash (as is the case at present). This moderates the impact of falling share prices overseas and makes our portfolio returns less volatile.
Of the portion allocated to the local stock market, half is also directly or indirectly exposed to offshore markets and shares, providing further rand hedge and diversification benefits. The top eight companies in the 10X Top 60 SA Share index are all international businesses. Some major stocks – such as British American Tobacco, Naspers, AngloGold Ashanti and Goldfields International – even benefited from the current crises and are up for the year.
A balanced portfolio will also diversify into cash and government bonds, which tend to hold their value better during a share market crash, as they did again this time around.
All these buffers supported your portfolio during the market melt-down. On 19 March, the current low point for this crisis, when the All Share Index was down 33% for the year, and the S&P 500 Index 31%, the 10X High Equity Index Fund had lost only 23%.
Both indices have since recouped some of their losses but are still 12% below where they started out on 1 January. The 10X High Equity Index Fund is down only 5%, a modest set-back in the context of what the world is facing right now.
Does de-risking your portfolio work?
No doubt, the thought has crossed your mind: what if something like this happens just before I retire? The good news is that if you follow a risk-appropriate investment strategy, it shouldn’t affect your pension much, if at all.
Besides fees, the main driver of your fund return is asset mix. This refers to how your savings are allocated between the different types of investments, mainly company shares, bonds and cash.
Shares are described as either high growth or high risk, depending on your time frame. They promise the highest return over time, but the short-term return is variable and even sharply negative some years. Investing in the stock market over many years is a great way to build wealth, provided you hold on during the occasional market correction and lower your exposure as your time horizon to retirement shortens.
You do this by switching more of your savings into cash and bonds. These are classified as either defensive or lower risk assets. They deliver more modest returns, but with little risk of a negative surprise. They are thus useful in preserving wealth.
A gradual transition from growth to defensive assets near retirement ensures that a market crash does not permanently reduce your pension.
This strategy also performed well over the past month (Fig 1). Although none of the portfolios were entirely immune from the market turmoil, those nearest retirement would have been least affected. At the worst point of the crisis, fund members less than 12 months from retirement (invested in the 10X Defensive Equity Index Fund if they did not opt out of the de-risking glide path) would have seen a maximum fall of only 4%, and a full recovery shortly thereafter.
Fig 1: R100 invested from 31 Dec 2019 to 30 April 2020
Investors in the 10X Low Equity Index fund, at one point down 10%, would also have recovered their losses by now.
No doubt, members in the Medium Equity Index Fund would have flinched on seeing their fund value drop 20%. That would frighten anyone with retirement in their sights. But they, too, have recovered most of their losses. And even if this recovery is short-lived, they can feel confident that this pandemic will be over within 18 months, some time before they retire, and that prospects should be much improved by then.
Build trust in the strategy
In these times, the investment industry regularly reminds savers to focus on their long-term goal and to ignore the immediate market swings, because these won’t matter by the time they retire. But that ignores the emotional toll of this pandemic. It may not threaten long-term retirement plans, but it does pose an immediate threat to their health, their livelihood, their lifestyle, and to their trust.
While this period will one day present as just another jagged edge on a long-term chart, a massive destruction of asset values and wealth perceptions, followed by a protracted recovery (as happened during the Great Depression in the 1930s, for example) will leave deep scars and negatively affect investors’ tolerance of market risk. This is usually to the detriment of their long-term return. Notwithstanding all the ‘keep calm and carry on’ messaging, it will cause some to lock in their losses anyway, by switching to a more defensive portfolio.
In the face of these vulnerabilities, investors should feel reassured by the resilience of their portfolio, and that their investment strategy is performing as expected.