Income Efficient Total Return Investors

A changing world

At Bridge Fund Managers we take our responsibility as asset managers and fiduciaries of our clients’ money very seriously. Our commitment to deliver better client outcomes is a central theme that permeates every aspect of our business.

In early 2012, we launched our first Payers and Growers® portfolios in response to years of observing inefficiencies that occur within the retirement savings market.  We have been gratified to see leading global finance specialists and retirement design practitioners independently corroborate some of our ideas. Academics such as; Wade Pfau, Michael Kitces, Moshe Molevsky, William Sharpe, David Blanchet and Robert Merton all recognise that current retirement solutions are not optimal and propose a fundamental change in approach.

Their published findings broadly illustrate that the pre- and post-retirement stages of lifetime savings have different risk, liability and cashflow demands.  They therefore require very different planning and portfolio solutions.

New ideas emerge

Coming to the market with new ideas that challenge the orthodoxy is never easy.  Even if ones’ ideas and solutions make perfect sense both academically and practically, it takes time (measured in years) for industry and market inertia to begin to shift. For example, one can think about how long it took people to consider taking their first ride in an Uber cab or booking their first holiday on AirBnB.

As a business we started talking about managing “sequence of return risk” in early 2013.  For the last five years, Bridge has been in focussed discussions with our advisors and their clients, explaining this concept and the manifestations of sequence risk.

Since 2013, no South African asset managers (at least those we are aware of) in the marketplace were using this term in their dialogues with clients and advisors. Fast forward to 2018.  It is exciting to see several progressive, large asset managers beginning to refer to sequence risk in their clients’ communications.

Why the recent shift? We are not entirely sure of the exact reasons why the industry has awoken to the reality of sequence risk, but one of the possible reasons is the lower than expected average returns by the ASISA Multi Asset High Equity and Low Equity categories (see Table 1 below) over the last 5 and 10 years that has impacted retirement savings and annual income drawdowns in living annuities.

Now that the industry has acknowledged the existence of sequence risk, advisors can begin to ask asset managers what strategies they propose to help manage this critical retirement risk. We would encourage all advisors to ask their preferred asset managers this important question.

Challenging the status quo

Over the last six years, we have had several engagements with established and influential industry participants over certain elements of our investment thinking.  Our proposed solutions have been scrutinised, deconstructed and in some instances misunderstood. Peer group discussions have generally centred around “the best” methods to structure pre- and post-retirement portfolios in order to manage the three key retirement risks namely; inflation, sequence of returns and longevity.

Amongst others, we have been portrayed as “income managers”.  We have also been criticised directly or by implication, for not focussing enough attention on delivering growth via capital returns.  Some industry experts have even categorised us as peddlers of fallacious arguments around capital base (unit) destruction within drawdown portfolios, the ultimate consequence of unmanaged sequence risk in our opinion.

Retirement plans are under stress using traditional models

The reality is that apart from the interesting arguments around different investment philosophies and processes, there are real people impacted by asset managers actions.  In the world of the client, these debates move from the philosophical level to a very practical level i.e. is my retirement on track and will I retire comfortably?

A glance at some nominal and real market returns over the last 5 and 10 years (to 31 March 2018), raises some interesting questions around traditional portfolio construction and asset allocation strategies.

Table 1.

Source: Moneymate, Bloomberg and Bridge Fund Managers. Returns are net of investment fees.

Let’s assume that retirement plans are generally based upon a CPI+5% p.a. average portfolio return over the term.  Cash (STeFI Composite Index) delivered real annual returns of 1.17% and 1.36% over the last 5 and 10-year periods respectively.  Not surprisingly, cash has been an inappropriate asset class to achieve a CPI+5% return goal in the long term. We would argue this finding would not be newsworthy. What is however surprising is the returns generated in the next two categories. Source: Moneymate, Bloomberg and Bridge Fund Managers. Returns are net of investment fees.

The average of the ASISA Multi Asset High Equity Balanced funds category (the preferred long-term retirement savings funds), delivered just 2.66% p.a. above inflation over the last 10 years.  By and large, the mandates for these funds incorporate a CPI+5% p.a. investment objective. This implies that any retirement plan based on this investment strategy over the last decade, would have (on average) delivered a return deficit of 2.34% p.a. relative to both the inflation target and the implied fund mandate. Unless outstanding future returns awaits this fund category in the next decade, the return shortfall will not easily be recovered, and investors will retire poorer than what they should have.

Similarly, in the ASISA Multi Asset Low Equity Balanced funds category (usually the preferred shorter-term retirement savings vehicles for those closer to retirement date), these funds delivered only 1.36% above inflation over the last 5 years.  By and large, the mandates for these funds would be a CPI+3% p.a. investment orientation.  Retirement plans based on this strategy would have on average delivered an annual return deficit of 1.64% under the inflation target over five years.  The above deficits are before taking advisor and platform fees into account, so the picture is not encouraging.

What can advisors do?

Advisors should be asking important questions about the impact of these lower than expected returns on their clients’ financial plans.  What were the causes, and more importantly could this “underperformance” be repeated in the next decade?  The most obvious conclusion we can draw from the lower returns generated, is that the asset allocation of the average industry fund was simply incorrect or too conservatively positioned to achieve the desired outcomes.

This view is corroborated by ASISA data showing composite asset allocations of funds within both these Multi Asset High Equity and Multi Asset Low Equity categories.  High levels of cash and bond holdings (non-growth assets) and large offshore exposures (exposed to volatile rand/dollar exchange rate risk) are observed perennially. Put plainly, unless asset managers are prepared to assume more market risk (higher volatility) by being more exposed to growth assets like domestic equities and real estate that provide a strong inflation hedge, higher total portfolio returns are unlikely to materialise.

Considered the Bridge Income Efficient Total Return solution?

At Bridge, we are true total return investors.  We construct portfolios that offer a high probability of achieving the required real return targets in the medium to long-term. Our two flagship balanced portfolios, since inception on 1 March 2012, have delivered amongst the highest total returns of all funds surveyed in their respective ASISA categories to 31 March 2018 (see Table 2).

We have achieved these outcomes by being fully exposed to growth assets that provide the necessary capital growth, even though the portfolios experience higher capital volatility in the short-term. The returns have also been delivered relatively consistently in relation to the peer group, maintaining top quartile performance versus the Peer Group across all meaningful timeframes.

Table 2.

Source: Moneymate & Morningstar – Bridge Managed Growth Fund (BMGF) ranking versus ASISA MA High Equity Category Average and Bridge Stable Growth Fund (BSGF) ranking versus ASISA MA Low Equity Category Average to 31 March 2018.

The portfolios also generate high levels of regular and dependable income in the form of dividends and property income from the growth assets.  The income produced has the benefit of growing through time and compounding alongside the investors growing need for an income stream post retirement.  This regular income helps us mitigate the sequence of return risk that comes through higher exposure to price-volatile growth assets.

The combination of these two return elements into a single portfolio strategy, helps the advisor manage the triple risks of inflation, sequence of return and longevity risk within a single portfolio. We call this our Income Efficient Total Return Portfolio strategy.

The next step

 In conclusion, our proposals have originated from a very real desire to contribute to the important and necessary debate around ways of improving retirement outcomes.  The fact that so few South Africans can retire in comfort and relative stability (significantly less than 10% of retirees according to the Sanlam Benchmark Survey 2016), says much about the way the savings industry has delivered its products and services over many decades.  We all need to take collective responsibility for these failings and commit to making the required improvements.

Should any advisors want to learn more about these topics and debates, we will be addressing many of these matters during our 2018 national roadshows, workshops as well as Meet the Managers 2018 Conference in Johannesburg and Cape Town.

We invite advisors to attend one of the sessions and hear our perspectives.  We will also offer some constructive steps that advisors can put in place to manage the associated risks.

Paul Stewart
Head: Fund Management