South Africa’s lower inflation rate is an opportunity for retirement funds to increase their allocation to cash, to achieve meaningful inflation-beating returns and reduce risk, says Sean Segar, the head of cash solutions at Nedgroup Investments.
Segar said that, for the first time since August last year, inflation is back within the South African Reserve Bank’s target range of 3% to 6%, and the Consumer Price Index for April was a lower-than-expected 5.3%, with the outlook for a stable environment looking good.
He said this creates an opportunity for retirements funds given the high levels of risk and uncertainty in the markets.
“The flat yield curve means that cash is also a good alternative to bonds, as it offers similar yields, without the volatility of returns. With so much happening on the domestic front and internationally, and with rating agencies camping in the country, bonds are vulnerable to capital loses. Many believe that for similar yields cash is a safer bet,” he said.
Segar added that, because retirement funds aim to earn steady, inflation-beating returns, they generally allocate to cash to provide a predictable and consistent positive return, not to generate a real (after-inflation) return.
He said cash is the ultimate positive-return asset class, having no volatility.
“When it comes to retirement savings, nobody likes surprises. Currently, however, given the low and falling inflation rates and relatively high yields, cash in retirement funds can comfortably achieve a 3% real return, which means that cash can make a significant contribution to benchmark-beating returns in a low-risk manner.
“This is a great opportunity for retirement fund trustees to increase their cash allocation and achieve better risk-adjusted real returns, which are crucial considerations for retirees given the current economic and political climate.”
Quaniet Richards, the head of institutional at Nedgroup Investments, said reducing or eliminating risk in retirement funds has become almost an overriding concern for retirement fund trustees.
“With the flat yield curve, low inflation and steady cash yields, it makes absolute sense for a higher cash weighting, as this will not compromise retirement fund returns, but will certainly improve the quality of returns.”
Segar said that, given the current yield on cash, increasing the allocation to cash not only serves as a valuable tool to lower risk, but it also contributes to delivering real returns.
He said the more cash in a retirement fund, the lower the overall risk of the fund.
“Furthermore, the liquidity of the cash allocation provides trustees with the flexibility to remain nimble in the current challenging environment and to easily and efficiently deploy the cash to other asset classes as the opportunities arise.”
Segar said the high real returns from cash reduce the potential “opportunity cost” of having a large cash allocation, as opposed to being invested in a higher-risk asset class. With risk a big concern for trustees, the opportunity cost is less of an issue.
He said a higher allocation to cash enables trustees to reassure members that a return of 3% above inflation is locked in on the cash portion of the fund, provided interest rates remain stable. The additional benefits are liquidity and not exposing members to additional risk.
He added that the growing number of money market funds that comply with regulation 28 of the Pension Funds Act (which governs retirement fund investments) are the ideal place for retirement funds to “park” or invest their cash.
“A money market unit trust fund is the ideal vehicle for a retirement fund to use as the cash building block in a retirement fund. These highly regulated investment vehicles offer the yields of fixed deposits, full liquidity, convenience and diversification, and are typically managed by specialists with large benefits of scale.”