European Debt Crisis Poses Significant Risk For SA Retirement Funds

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Retirement funds in South Africa face the very real prospect of low or even negative returns over the medium term, fuelled by the ongoing European debt crisis.

According to Rob Spanjaard, investment director at Rezco Asset Management, the World Bank revised its growth estimate for developing economies down to 5.3% this year, from 6.1% in 2011, whilst cautioning that there could be long period of volatility in the global economy as the Eurozone debt crisis escalates.

“While the Rand depreciation is softening the impact of weaker demand for South African exports, the expected lower economic growth rate and a flight to safety by offshore investors could hurt local equity markets.”

“As a result, we believe local retirement funds are likely to face another period of very low or negative growth over the next 12 – 24 months.”

“This will affect retirement funds’ ability to meet member’s expectations with a corresponding decrease in replacement ratios. As a result, these members are likely to retire with even less security in the future.”

He says the European crisis will further exacerbate the position of the ‘sandwich generation’ – those fund members who are caught between subsidising their parents’ retirement and providing for their family’s needs. “Many of these members will retire with significantly less than they require, as they have been unable to contribute at adequate levels, whilst at the same time having experienced significantly lower market growth for longer periods of time.”

Spanjaard says that while the risks remain high for local retirement funds, there are measures they can put in place to mitigate the impact. “Firstly, trustees must aim to protect against any potential loss and secondly aim to participate in any market upside. With current market levels being so high, trustees need to have a very clear and measureable risk management strategy in place that will ensure the achievement of their long term goals during this period of volatility and downside risk.”

“There is a danger that as a result of this short term volatility and downside risk, some trustees might consider a short-term tactical asset allocation overlay that is more focused on downside protection and less focused on growth. It is vital that trustees have a very clear understanding of their investments and whether the current asset allocation is in line with their long-term strategic asset allocation, or if the manager has a short-term tactical overlay on the exposures.”

Spanjaard says that while the current global environment remains very uncertain from a technical market perspective; of even more concern from a behavioural finance perspective is the fact that when investor irrationality takes over, markets and asset classes can then move in the same direction.

“The European crisis shows no sign of abating in the near future. However, given the current levels of uncertainty in the markets, it is more crucial than ever for trustees not to react to short term market volatility but to consider the impact this may have on a fund’s long term investment objectives and to ensure that it is positioned appropriately,” concludes Spanjaard.