Know your risk profile in volatile markets

By Staff Writer
The volatility in the equity markets at present highlights the need for pension funds to ensure members' investments are appropriate for their risk profiles, generally defined by age, or rather, time to retirement.

According to Roger Birt, Head of Guaranteed Investment Portfolios at Old Mutual Corporate, volatility refers to the measure of uncertainty or risk attached to the size of fluctuations in the value of an investment. High volatility suggests a "fearful" market.

To give an indication of the current level of volatility, at the height of the recent financial crisis, the South African Volatility Index (SAVI), which is a key measure of the volatility in the domestic equity market, recorded 58 points on 27 October 2008 and since then it has been on a downward trend, reaching a low point of 19 on 6 April 2010. However, the SAVI has been on an upward trend since the acceleration of the European Debt Crisis in May and June this year and measured 30 points on 10 June 2010. It has stubbornly remained above 25 since the end of August 2010.

Birt believes that this is clear evidence that levels of investor fear have increased in a relatively short period and presents dangers for members not correctly invested in line with their risk profiles.

"The danger of this is that members who are too aggressively invested can be severely affected by dips in the market," he says.

A member close to exiting a retirement fund mainly faces what is known as exit risk and, as such, Birt recommends that the primary focus of the investment strategy should be the protection of the accumulated retirement savings.

"Members invested too aggressively given their risk profile, will lose a significant portion of their retirement savings in the event of a dip in investment markets. Furthermore, given that the time to retirement is short, these losses are unlikely to be recovered," he says.

Birt warns that a loss in retirement savings close to retirement, which may be incurred in a matter of months, will mean that members will receive a lower income for the rest of their lives in retirement. "In some instances, this lowered income may be insufficient to meet living costs and therefore a member may be forced to delay retiring."


On the other hand, the main risk to a member of a retirement fund that is too conservatively invested is that the returns on his or her savings turn out to be lower than expected and that ultimately, the member retires with too little savings to provide for the rest of his/her life.

Birt stresses that it is important to take into account the risk profiles of members when looking at how conservative or aggressive investments are. "Generally speaking, younger members can afford to take more risk, and prefer more aggressive investments, as they can ride out any severe dips in the market as they have more years to recover. The risk of being too conservatively invested is the greatest for younger members," he says.

The point is that no matter what the age of the member, there is always a risk of being too conservatively invested. It is also true that, no matter what the age of a member, there is always the risk being too aggressively invested (for example a young member could be very risk averse by nature, and would therefore not want to tolerate negative returns).

For trustees, it is important to take both these elements into account, and to ensure that their members have the option to invest in products that offer both growth and protection. The Old Mutual Absolute Growth Portfolios are examples of products that not only provide both these elements, but also allow a choice through offering varying levels of protection with accompanying return targets.

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