In the 12 months to the end of April, the typical South African retirement fund lost about 14 percent of its rand value. We take a closer look at the market conditions that tripped up portfolio managers across the board.
The first quarter of 2003 left investors reeling, with many market-linked portfolios losing close to 10 percent of their value over the quarter, after allowing for tax and investment management fees.
Erich Potgieter, a director of Fifth Quadrant Actuaries & Consultants, is co-author of a quarterly report on the performance of retirement fund portfolios. He says this year's losses "followed several months of market weakness starting in the second half of 2002. In fact, the 12 months just passed were probably the worst for investors since the 12 months that ended with the August 1998 stock market crash. And despite the recovery in May, we cannot be certain that the worst is over."
What makes things worse, Potgieter says, is that inflation rose by an average of more than 10 percent over the year, even taking into account the recent revision of the official inflation rate figures.
This means that, over periods of up to five years, many retirement fund investment portfolios failed to keep up with inflation.
"This is most disappointing, but one should remember that the five-year period from April 1998 to March 2003 did include the August 1998 crash as well as the extreme market weakness experienced over the past few months, so we can hope that it is the exception rather than the rule," Potgieter says.
It is normal for retirement funds to invest their members' money in a range of different asset types, including shares, bonds, cash and property, and to invest part of the money overseas in terms of the regulation allowing funds to hold around 15 percent of their investments offshore.
"Over the 12 months to the end of March this year, the typical retirement fund manager showed losses on his global balanced investment portfolios of around 11 percent, before tax and fees - which would take the total loss closer to 13 percent," Potgieter says. "And with the revised headline inflation figure of 10.2 percent for the year, many retirement fund members will have suffered a capital loss of close to 25 percent of their investments over this 12-month period."
Over this year, the best-performing global balanced portfolio - and the only one to achieve a positive return - was the Allan Gray Full Discretion Global Fund. It delivered a return (before tax and fees) of almost four percent, but failed to beat inflation. The worst performer was Sanlam's Impetus Plus pooled fund, which lost almost 18 percent.
Potgieter says that most retirement funds spread their investments among several managers (either directly or by using multi-managers such as Investment Solutions or M-Cubed), so few fund members would have been lucky enough to have all their money invested with Allan Gray, or unlucky enough to have it all in the Sanlam fund.
Past experience and conventional wisdom in the investment industry says that, over the long term, investing in shares is likely to produce the best returns and the best protection against inflation. For this reason, funds have typically invested around 65 percent of members' money in shares - mostly on the JSE Securities Exchange, but also, to some extent, on stock markets in the United States, Europe and the Far East.
Potgieter says investment in shares always carries a degree of risk because share prices can fluctuate dramatically - up or down - in sudden and unpredictable ways. This was illustrated by the stock market crash of August 1998, when share prices on the JSE fell by an average of about 30 percent in a single month. Since then, the JSE has had periods of strength and weakness, with share prices reaching an all-time high in May 2002.
However, from June 2002 the market started to fall quite sharply, until, by the end of April this year, share prices had again generally fallen by around 30 percent compared with the level a year earlier. The reasons for this are complex, Potgieter says, but it is no coincidence that the fall occurred with the sudden strengthening of the rand (after the "rand crisis" currency weakness at the end of 2001). Generally, investors were bullish on the South African stock market when the rand was weak (driving share prices up to the highs that we saw a year ago), but became more and more bearish as the rand strengthened.
"Retirement funds have been badly affected by the sharp fall in the market, especially since it coincided with the sudden rise of the rand, which meant that their overseas investments lost value in rand terms.
"In the first quarter of this year, the stock markets in the developed economies were jittery because of concerns about global economic weakness and the looming war in Iraq, but the main driver of the dismal returns for South African investors was the strengthening of the rand.
"The effect of this was that most retirement fund managers lost about nine percent in rand terms on their offshore portfolios over the first quarter, compounding the losses they had made in 2002. However, the first-quarter returns on domestic portfolios were so poor that the losses on the offshore investments didn't make things much worse."
Over the longer period of 12 months to the end of April 2003, the typical South African retirement fund lost about 14 percent of its rand value as a result of market falls and the strengthening of the rand. Of course, the law requires that all funds invest at least some of their money - a minimum of 25 percent, but usually more - in cash and bonds, and this has certainly helped to mitigate the losses for members, which clearly illustrates the benefit of spreading one's investments, Potgieter says.
The good news for fund members (and investors generally) is that the stock markets recovered strongly during May 2003, with share prices on the JSE rising by about 14 percent on average. The rand also weakened to some extent, and overseas markets did well, so foreign investments had a particularly good month, with returns likely to be around 15 to 16 percent in rand terms.
Indications are that many funds will show growth of 10 percent or even more, for the month of May. This means that many fund members will have recovered a good part of the losses they have suffered over the past few months.
Potgieter says it is very difficult to predict where share prices and the rand will go next. The global economic climate is not healthy and political uncertainty continues in the Middle East, which means, from a global perspective, it is possible that there will be further episodes of stock market weakness, which will affect the JSE too.
Domestically, the economic outlook will definitely benefit from a slightly weaker rand, and also from further interest rate cuts that are eagerly expected by most economists and investment managers. These two factors were undoubtedly the main "drivers" of the market recovery during May, and could continue to help support share prices on the JSE over the coming weeks and months.
However, as Potgieter is quick to point out, recent events have been a sharp reminder to all of us that equity investment will always be a risky business.
This article was first published in Personal Finance magazine, 3rd Quarter 2003. See what's in our latest issue