Unlocking financial stability for retirees: The power of global investments

Global investments have always been an area of high interest for South Africans. With the South African Reserve Bank (SARB) increasing the offshore allowance to 45% in retirement funds a few years ago, the spotlight on global investments has intensified. This raises crucial questions for financial planners: how much should retirees invest globally, and what impact does this have on their retirement outcomes?

The power of getting a retiree’s global allocation right

Imagine, several years ago, meeting with Harry and Sally, two delightful clients on the brink of retirement. Both had the same sensible initial drawdown of 4% and an identical asset allocation to equity, property, bonds and cash. The only difference? Their allocation to global assets. Harry believes that local is lekker and has 100% invested in South Africa, while Sally has invested 70% globally.

Fast forward to today, markets have crashed[1], and it's time for their annual review meeting. As a financial planner, you're feeling anxious about your meeting with Harry this afternoon because he is on the verge of running out of money. This leads you to wonder if Sally was also in trouble? You check her statement, and you’re surprised to see that she’s thriving, which is a relief. In a time of crisis, Sally can draw up to 24 additional years of income and her secret was to have 70% invested globally, while Harry had 100% invested in South Africa.

As a financial planner, that also means 24 years more of income for you to earn in a time of crisis.

Both these retirees had very sensible drawdowns. What about your more conventional retiree who starts with an initial drawdown of 6% in year one and experiences more typical markets? What difference can the global allocation make? The answer is 11 years of income. This is still very significant and now the tables have turned; the client that ran out of money earlier has all their assets invested globally whereas in the previous example, Harry, who ran out of money earlier, had all his assets invested locally. Being on either extreme of the global allocation spectrum is risky.

This is interesting, but what we really need are global allocation guardrails and rules to apply to various retirees. This is where our research comes in.

Research testing outcomes across market cycles and economic conditions

Our extensive research was conducted across approximately 1 000 scenarios using data from the Big Picture App. These results are stress-tested through various market cycles, exchange rates, and economic conditions. The research was done for clients investing for 5 years and more, so the portfolios tested are all high equity portfolios with 72% in risk assets.

The research was conducted by the Nedgroup Investments Core Investment team, which has a lot of experience with asset allocation modelling. This is one of the big benefits of having a focused range that tracks the market. It gives us time to conduct in-house and in-depth research and have a relentless focus on constantly enhancing the range. For example, all this global allocation research is incorporated into the Nedgroup Investments Core Multi-Asset range allocations, which provides comfort in knowing that your clients are perfectly positioned for all their financial planning needs.

Solving what matters to retirees

When we considered retirees, we believe there are three objectives that are important to retirees and to you as a planner, and your aim is to:

• Maximise the number of clients who can draw an income for at least 30 years, and
• Ensure that when a client misses the 30-year target that the income lasts for as long as possible, and
• Maximise the average assets the client has at 30 years (e.g. max inheritance)

In practice, achieving all three objectives simultaneously is often challenging, requiring a balance among them.

[1] A time of crisis means the worst outcome of the scenarios tested.

Harry and Sally: 4% initial drawdown

Let’s come back to Harry and Sally, who initially had a 4% pa drawdown. Looking at the chart, we can see that client like Harry with 100% invested in SA, would have succeeded in 94% of scenarios. In other words, they would have been able to growth their income with inflation for at least 30 years without running out of money. Those seem like great odds. In fact, I think any planner would be very happy if 94% of their clients were successful. On the other hand, clients like Sally, would have succeeded in all 1000 scenarios.

Source: Nedgroup Investments and the Big Picture App using fees of 0.5% pa with assets invested in 72% equity, 21% bond and 7% using various global allocations

Looking at the chart above, regardless of the percentage in global investments, the success rates all look very high and as a planner you would probably be happy with your client choosing any global allocation based on this chart. So, how bad does it get when clients miss the 30-year mark?

Source: Nedgroup Investments and the Big Picture App using fees of 0.5% pa with assets invested in 72% equity, 21% bond and 7% using various global allocations

The worst scenario that Harry, who invested 100% in South Africa, could have experienced is that his money ran out after 16 years. That is missing the 30-year target by a mile. Sally on the other hand, in the worst scenario, still had money after 40 years and even potentially longer (as the scenarios are capped at 40 years). If we look at the average outcomes across all scenarios, then we see that regardless of the global allocation, on average clients can draw their desired income for 40+ years. Therefore, on average we would be indifferent to the global allocation. Getting the global allocation right for the Harry and Sally’s of this world is all about providing downside protection when markets crash.

Considering the 3 objectives i.e. the probability of success, the average and worst number of years that income lasted and the inheritance, a client with a 4% initial drawdown invested in a high equity fund should ideally allocate 40-70% to global[2]. The reason the global allocation is capped at 70% is that the average balance at the end of the 30 years drops off significantly above 70% global. This represents the typical inheritance of the client.

Typical retirees with 6% initial drawdown

Unfortunately, not all our clients’ have such low, sensible drawdowns like Harry and Sally. So, how should we position clients that have more typical drawdowns? Let’s look at the second example we shared of a retiree who initially draws 6%.

[2] Based on this study, the data used, assumptions and objectives.

Source: Nedgroup Investments and the Big Picture App using fees of 0.5% pa with assets invested in 72% equity, 21% bond and 7% using various global allocations

Now, the likelihood of our clients succeeding has dropped dramatically, with only every 2 out of 3 clients’ income lasting for at least 30 years for most global allocations. However, if we were to allocate 90-100% to global then every second client’s income would run out before the 30-year mark. That’s abysmal.

Given the high chances of clients not making the 30-year mark, it’s critical to understand how bad things can get.

Source: Nedgroup Investments and the Big Picture App using fees of 0.5% pa with assets invested in 72% equity, 21% bond and 7% using various global allocations

Interestingly enough, there isn’t that much difference in the worst outcomes across the global allocations. Depending on the global allocation, a client's income could last between 11-15 years in the worst scenarios. All these outcomes would be disastrous. However, there is little difference between them.

What does matter, for this group of clients, is that the global allocation has a noticeable difference on the average outcomes. Clients with 30% in global investments, would run out of money in year 37 on average, whereas clients with 100% invested globally would run out of money in year 26 on average. That’s an 11-year difference, which means that it’s critical to get the global allocation right with clients with a 6% drawdown. This is no longer about downside protection, but about the average outcomes.

In terms of the inheritance, the client’s average balance at the end of the 30 years drops off after 40% global allocation.

Considering all three objectives, with inheritance being treated as a nice to have, the ideal range[3] for clients invested in high equity with an initial drawdown of 6%, is 20-50% in global.

Practical application for financial planners

Retired clients' investments are very sensitive to the percentage invested globally. The higher the drawdown, the lower the allocation that retirees should invest globally[4].

[3] Based on this study, the data used, assumptions and objectives.

[4] Based on this study, the data used, assumptions and objectives.

Source: Nedgroup Investments

1. Avoid extremes: Holding very little or close to 100% of investments globally increases risk and results in suboptimal outcomes, even in typical markets.
2. Sensible drawdowns: For clients with drawdowns of around 5% per annum or less, a global allocation of 40-70% is ideal in a high equity portfolio[5].
3. Higher drawdowns: For clients with higher drawdowns, a global allocation of 20-50% is ideal in a high equity portfolio[6].

[5] Based on this study, the data used, assumptions and objectives.

[6] Based on this study, the data used, assumptions and objectives.