By Fred White, 27 March 2019
“Longevity is a big problem and causing shortfalls in retirement,” said Fred White, head of Balanced Funds at Sanlam Investment Management (SIM) at the recent All Access Summit hosted by Sanlam Investments. To illustrate the amplitude of the problem, he used the latest longevity data from Sanlam’s actuarial team.
According to Sanlam’s actuarial tables, a male born in 1967 can expect to live to age 91. A female will live even longer. On average, we need to prepare for someone born in 1967 to live up to age 95 years. For many employees, their company retirement date is set at age 60. Assuming that one starts working at age 25 after a few years of studying, 35 years of working life have to provide for 35 years of retirement. That is a daunting 1:1 ratio!
“So, if you’re not getting a real return, the reality is you need to live off only half your salary while working and save the other half to start living off from age 60. And you have to be satisfied that at some point in the future you’ll have to start living off the same level of income as when you first started working. Or you’ll be facing a shortfall,” Fred said.
Fred co-manages the
SIM Balanced Fund along with Ralph Thomas. When these two managers took over the fund, they realised that investors were choosing the fund mainly as a long-term return oriented solution.
“Investors choose balanced funds not for the same solution as absolute return funds. They come to a balanced fund because they want growth,” Fred said. “That’s why we will, on average, have a bias to growth assets.”
Fred pointed out that, despite most growth assets trending sideways over the most recent four years, over the past 13 years growth assets have provided significant outperformance versus fixed income assets (and that includes the poor performance of the past four years and the drawdowns of the great financial crisis).
Growth assets do come with the complication of larger drawdowns, though. The most important thing that investors need to remember is that drawdowns recover again and over the very long term the outperformance of growth assets over bonds have been consistent. Fred warned that investors need to prepare themselves for interim periods in which the opposite is true, i.e. when fixed interest assets outperform growth assets. Occasionally, this can be true, but the timing of such events are near impossible to predict. Therefore, if you have a bias towards growth assets you need a supplementary protective strategy that looks at drawdown risk.
Fred and Ralph spend the bulk of their time looking for ways to firstly enhance returns and secondly find protective strategies that supplement their growth bias.
An example of how the managers enhance the returns of the SIM Balanced Fund is the fund’s exposure to a unique basket of international real assets – a carve-out from one of Sanlam’s UK-based absolute return funds. Fred said, “The real assets have long-term rental contracts in place and most of them have escalation clauses that link the income growth of these assets to inflation. The real assets include property, infrastructure and renewable energy, but also interesting assets such as music rights and aircraft leasing, for example. We didn’t want to make an allocation to the entire absolute return fund, so we managed to arrange a carve-out of the real assets in which we were interested.”
Fred emphasised that the SIM Balanced Fund is not an absolute return fund; it’s not looking to eliminate drawdowns over any one-year period completely. “We attempt to avoid portions of large drawdowns.”
Keeping in mind that protective strategies are a type of insurance, and insurance always comes at a cost, the fund managers keep the insurance cost (which often manifests itself as an opportunity cost) as low as possible to not compromise potential returns unnecessarily. For example, if equities were to fall by 30%, the managers’ objective would be to avoid half that fall – not the entire fall. “Protecting against the entire fall would be too expensive,” Fred said. “We only put protective structures in place if we believe they can enhance the long-term returns of the fund by cancelling out part of the downturns.”
When Fred and Ralph say that they understand the longevity challenge that investors face and that they manage the SIM Balanced Fund so as to maximise long-term growth without taking on undue risk, it’s not just talk. They have bet the proverbial “farm” on it. The fund managers hold no other significant long-term investable assets other than their units in the SIM Balanced Fund. “Even our share options have been folded into units in the fund we manage and they only start vesting on the day we retire,” Fred disclosed. “We are fully invested alongside our clients for many years to come.”