LIVING ANNUITY CRISIS: FACT OR FICTION? Hamilton van Breda March - - PowerPoint PPT Presentation

CONSISTENCY IS THE ONLY CURRENCY THAT MATTERS. Explore more at consistency.co.za

LIVING ANNUITY CRISIS: FACT OR FICTION?

Hamilton van Breda

March 2018

Slide 2

Slide 3

IS THERE A LIVING ANNUITY CRISIS?

Source: Prudential Investment Managers

60 100

60 60

Years old

100 100

Years old

Fees Longevity Investment returns Investor behaviour

Slide 4

Source: GenRe; US Social Security Administration

LIFE

12 YEARS Education 47 YEARS Employment 19 YEARS Retirement

18 18

Years old

65 65

Years old

84 84

Years old

Investment Phase Withdrawal Phase

Typical scenario for “Silent Generation” & “Baby Boomers”

Years

• ld

INVEST : WITHDRAWAL RATIO = 2.47

Slide 5

Source: GenRe; US Social Security Administration

LIFE

Investment Phase Withdrawal Phase

38 YEARS Employment 26 YEARS Retirement 16 YEARS Education

22 22

Years old

60 60

Years old

86 86

Years

• ld

Typical scenario for “Generations X & Y”

Years

• ld

INVEST : WITHDRAWAL RATIO = 1.46

41% REDUCTION

Slide 6

WHY IS THE RETIREMENT AGE 65 IN MOST DEVELOPED COUNTRIES?

Source: Tim Kastelle (University of Queensland Business School) & Berkeley Demography

USA SA Japan Australia Retirement age 30 40 50 60 70 80 90 1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Overall life expectancy at birth

Slide 7

COUNTRIES BY LIFE EXPECTANCY

Source: The US CIA published the following life expectancy data in its World Factbook.(2016)

85.6 81.7 82.3 81.6 80.7 80.9 80.3 80.6 80.3 79.9 93.5 88.5 87.8 87.6 86.1 85.3 85.8 85.1 85 85.4 70 75 80 85 90 95 Monaco Japan Singapore Macau ( China) San Marino Iceland Hong Kong ( China) Andorra Switzerland Guernsey Age Male life expectancy at birth Female life expectancy at birth

Slide 8

SOUTH AFRICA’S IMPROVING LIFE EXPECTANCY

Source: STATS SA

62 62 62 63 63 63 63 63 64 64 64 64 65 65 65 65 69 69 70 70 70 70 70 71 71 71 71 71 71 72 72 72 56 58 60 62 64 66 68 70 72 74 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Assumptions of expectation of life at birth without AIDS and fertility

Male Female

TYPICAL RETIREMENT PLANNING PARAMETERS

Slide 10

TYPICAL RETIREMENT PLANNING PARAMETERS

Source: Prudential Investment Managers

Typical Retirement Planning Parameters Base plan Pre-retirement investment term 30 Retirement savings % 15% Drawdown rate 7% Growth rate in retirement (Net Real Return p.a.) 4% Replacement ratio 60% Years to running out of money 21.3 Reduce drawdown rate 30 15% 5% 4% 43% 39 Save more 30 22.5% 7% 4% 90% 21.3 Reduced exposure to growth assets 30 15% 7% 1% 60% 15.8 Higher exposure to growth assets 30 15% 7% 6% 60% 30.4

Slide 11

BALANCING THE REAL RISKS

Source: Prudential Investment Managers

Longevity Risk Sequence & Behaviour Risk

Balancing returns and risk 20.98 3.02 2.01 5 10 15 20 25 Dec-77 Dec-87 Dec-97 Dec-07 Dec-17 Equity 7.9% per year Bonds 2.8% per year Cash 1.8% per year

Cumulative returns on SA assets classes in real terms 1977 to 2017 (40 years) R1 invested

SEQUENCE OF RETURN RISK

Slide 13

R.0m R.5m R1.0m R1.5m R2.0m R2.5m R3.0m R3.5m R4.0m 65 68 71 74 77 80 83 86 89 92 95 98 01 04 07 Investment Value Investment Start Date

TWO IDENTICAL INVESTORS

Source: Prudential Investment Managers, GMO

• Same investment term
• Same salary and growth
• Same contribution rates
• Same asset allocation

Same 5% p.a. average real return JOE JANE

R2 681 423 R3 601 375

Slide 14

• 15%
• 10%
• 5%

0% 5% 10% 15% 20% 25% 30% Starting High Smooth Starting Low Annual Returns

SEQUENCE OF RETURN RISK

Different order of annual returns over 25-year investment term

Source: Prudential Investment Managers

Slide 15

EXAMPLE 1: R100 000 LUMP SUM INVESTMENT

Different journey, but same end result

Source: Prudential Investment Managers

R0m R1m R1m R2m R2m R3m 5 10 15 20 25 30 Investment Value Investment Term Smooth Starting High Starting Low R1 729 472

Slide 16

EXAMPLE 2: R50 000 p.a. REGULAR INVESTMENTS

Sequence of returns matter when there are cash flows during investment term

Source: Prudential Investment Managers

R0m R4m R8m R12m R16m R20m 5 10 15 20 25 30 Investment Value Investment Term Smooth Starting High Starting Low R17 391 255 R9 097 171 R5 444 482

Slide 17

R0m R1m R2m R3m R4m R5m

• 1.0%

0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% Fund value at end 40-Year Annualised Real Return (50% SA Equity/50% SA Bonds) 20 000 investor simulation

SEQUENCE OF RETURN RISK

Huge variation in investor outcomes, even for same average return

Source: Prudential Investment Managers

R3.3m R1.0m

Slide 18

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% R1.03 R1.26 R1.50 R1.74 R1.98 R2.22 R2.46 R2.70 R2.94 More Distribution of outcomes Millions

WIDE DISTRIBUTION OF OUTCOMES FOR THE 5% P.A. GROUP

Simulated outcomes: 5% real over 40 years

Source: Prudential Investment Managers

UNLUCKY 20% LUCKY 20%

Slide 19

TWO IDENTICAL INVESTORS

Source: Prudential Investment Managers

R0m R1m R1m R2m R2m R3m R3m 65 68 71 74 77 80 83 86 89 92 95 98 01 04 07 Investment Value Investment Start Date JOE JANE Income received R2 120 441 R2 393 040

R1.68m R1.53m

Slide 20

EXAMPLE 3: R50,000 p.a. (5%) REGULAR WITHDRAWALS

Sequence of returns matter when withdrawing income during retirement

Source: Prudential Investment Managers

R5 409 088

R0m R4m R8m R12m R16m R20m 5 10 15 20 25 30 Investment Value Investment Term Smooth Starting High Starting Low R768 201 R9 224 701 R12 714 974

R1m retirement funding

Slide 21

WHAT CAN YOU DO TO MITIGATE SEQUENCE RISK?

Source: Prudential Investment Managers

Define the problem correctly Reducing volatility

• vs. minimising the

probability of running out of money in retirement Contribute more in the accumulation phase Enables lower and/or flexible drawdown in retirement Diversify between asset classes A balanced portfolio can reduce both the volatility of returns and the severity of negative return periods, without significantly impacting total returns Take a valuation- sensitive approach to active asset allocation

Slide 22

“By failing to prepare, You are preparing to fail.”

Benjamin Franklin

IF YOU HAVEN’T STUDIED FOR YOUR EXAM BUT STILL PITCH UP TO WRITE IT

Slide 23

R0m R2m R4m R6m R0m R2m R4m R6m R8m R10m R12m R14m 30 35 40 45 50 55 60 65 70 75 80 85 Annual Salary/Income Investment Value Age

LIVING ANNUITY GOING THE DISTANCE

Base case: 4% real return

Source: Prudential Investment Managers

15% retirement allocation

(4% real return)

Salary increasing by 6% inflation Income increasing by 6% inflation 60% replacement ratio 4% real return Retirement Value Annual Salary Retirement Income Investment Value

Slide 24

R0m R2m R4m R0m R6m R12m R18m 30 35 40 45 50 55 60 65 70 75 80 85 Annual Salary/Income Investment Value Age

LIVING ANNUITY GOING THE DISTANCE

Reduce growth assets post retirement: 1% real return

Source: Prudential Investment Managers

1% real return Retirement Value Annual Salary Retirement Income Investment Value

Slide 25

LIVING ANNUITY GOING THE DISTANCE

Increase growth assets post retirement: 6% real return

Source: Prudential Investment Managers

R0m R2m R4m R0m R5m R10m R15m R20m R25m 30 35 40 45 50 55 60 65 70 75 80 85 Annual Salary/Income Investment Value Age 6% real return Retirement Value Annual Salary Retirement Income Investment Value

Slide 26

DON’T GIVE UP GROWTH IN RETIREMENT

Source: Prudential Investment Managers

R0m R4m R8m R12m R16m 30 35 40 45 50 55 60 65 70 75 80 85 Investment Value Age

14% 86%

Retirement Value Money under the mattress Retirement Value

Assumption 4% real return p.a.

Slide 27

THE VALUE OF GROWTH ASSETS

Source: Morningstar, ASISA and Prudential Investment Managers

SA MA Low Equity (after income) SA MA Income (after income) R0k R200k R400k R600k R800k R1,000k R1,200k 03 05 07 09 11 13 15 17 Income (7%) R9m R10m R11m R12m R13m R14m R15m R16m 03 06 09 12 15 18 Investment value (after income) R13 610 253 R12 289 337

Slide 28

FUND FLOWS FOLLOWING SHORT-TERM PERFORMANCE

Source: Morningstar, ASISA and Prudential Investment Managers

Investment Value (After Income)

• R5bn

R0bn R5bn R10bn R15bn R20bn R25bn R9m R10m R11m R12m R13m R14m R15m 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 SA MA Low Equity (after income) SA MA Income (after income)

Slide 29

HOW PRUDENTIAL CAN HELP YOU

Source: Morningstar, ASISA and Prudential Investment Managers

SA MA Low Equity (after income) Prudential Inflation Plus Fund (after income) R0k R200k R400k R600k R800k R1,000k R1,200k R1,400k R1,600k 03 05 07 09 11 13 15 17 Income (7%) R9m R11m R13m R15m R17m R19m R21m R23m 03 06 09 12 15 18 Investment value (after income) R13 610 253 R17 037 479

Slide 30

HOW PRUDENTIAL CAN HELP YOU

Source: Morningstar, ASISA and Prudential Investment Managers

R0k R500k R1,000k R1,500k R2,000k R2,500k 03 05 07 09 11 13 15 17 Income (7%) R8m R13m R18m R23m R28m R33m 03 06 09 12 15 18 Investment value (after income) SA MA High Equity (after income) Prudential Balanced Fund (after income) R19 234 917 R21 768 302

Slide 31

0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% Fund A Fund B Fund C Fund D Fund E Fund F Fund G Fund H Fund I Fund J

THE IMPACT OF CLIENT BEHAVIOUR

Source: Morningstar

10 Funds = R437.6bn Time-weighted (Fund Return) Money-weighted (Client Return) Average difference = -3.5% p.a. (16.6 years)

• 5.3%
• 4.6%
• 4.4%
• 3.7%
• 3.5%
• 3.1%
• 2.8%
• 2.8%
• 2.5%
• 2.4%

Funds offer 68% more than what investors achieved.

Slide 32

THE IMPACT OF CLIENT BEHAVIOUR

Source: Prudential Investment Managers

• 3.5% p.a.

20 years

80 80

Years old

60 100

60 60

Years old

100 100

Years old