Saving for retirement is something most people seldom think about when they’re young. While they might scrutinize their employee benefits record to see how much they’re contributing to a pension or provident fund, few people scrutinize where their money is actually going. Where to save for retirement is just as important as how much to save. Putting R5 000 a month for 40 years in a portfolio that returns 9% a year will result in much less money than a portfolio that returns 14% per year. In fact, the difference would be R9.5 million. That’s a life-changing amount. Clearly, choosing a portfolio for your retirement savings is one of the most important financial decisions you’ll take. But many investors do not spend enough time on the issue. The PSG Balanced Fund has returned 14.7% per year since it started in June 1999, avoiding a low-risk low-return philosophy and opting for exposure to the high-risk asset classes over a longer period. David O’Sullivan spoke to Co-Fund Manager of the PSG Balanced Fund, Paul Bosman, about the fund.
*This podcast is brought to you by PSG Asset Managers.
Well, I think for a lot of employees, they see their employers deduct a certain amount from their salary. It goes in a fund and they don’t really pay much attention to where that money is being invested. How important is it for people to know where the money is going and what portfolio they’re investing in?
Very often, the focus is on how much is being deducted and there’s a lot of recommendations and rules of thumb on how much you must save every month for your pension but there’s much less focus that really goes into exactly where that money is going. Very often, it’s a decision that employees are very happy to outsource to somebody else or they just take a default option and what very often happens then, is that you end up in a lower risk fund than you really should be in. That’s the one route in which people end up in the lower risk bucket. The other way is when they just don’t have the stomach to take the risk they should be taking, and choose a lower risk fund than they should choose. Getting the fund’s risk profile right is the first step. For example, we did a calculation. You might typically save every month for your pension for 40 years and we took a number of R5 000.00 which grows by inflation annually.
If you invested it in a fund at 9% per year, which is more than your typical stable fund return (so that will be your lower risk kind of fund) then in today’s money terms, you would retire with R4.3m. However, if you went for the more balanced fund kind of returns (so we assume 14% per year), you would retire with R13.8m so that’s a gigantic difference and that would make a huge difference in terms of lifestyle during your retirement years. That’s the main rule for us: to make sure that you’re invested in a fund that is suitable for the duration of your investment, which is very much a long-term focus.
Since the PSG Balanced Fund’s inception in June 1999, what kind of return have you been achieving per year?
After fees, it’s been 14.7% so slightly more than the 14% indicative number that we use.
With retirement, you’ve got a long-term horizon, haven’t you? You’re then recommending the exposure to the higher-risk asset classes.
Yes, that’s right. The Balanced Fund is already constrained in terms of how much risk it can take. Its maximum equity exposure, so its exposure to shares, which is typically regarded as a riskier asset class is capped at 75%. There’s already a risk management overlay by regulations so to add another risk management/avoidance by the individual would probably not be that prudent. It depends on where they are in their stage of life. Obviously, if you’re approaching retirement, things could change but when you’re young and you start working, the Balanced Fund is certainly the correct vehicle for that. Risk is already managed and the irony is that equities seem risky in the short term because they can be quite volatile but in fact, what is quite risky in the long-term, is being in cash because then you know you won’t beat inflation in the long run. In the long run, equity is actually the lower risk asset class if you’re selecting the equities correctly.
It’s a huge responsibility, managing your clients’ pension funds. What principles do you apply when you go about executing that responsibility?
Firstly, we buy securities with some inherent qualities – what we call moat and management. We look at the competitive advantage of that company in its marketplace (its moat) and we assess the quality of the management team of the business. Secondly, we try to never overpay for a security. If you pay more for something than it’s worth, you’re introducing risk because the differential between what you’re paying and what it’s worth would probably narrow over time. Thirdly, we do diversify across industry, asset classes, and geographies in to ensure that we don’t build highly correlated portfolios. 
So how do you know which industries to invest in?
We follow a bottom-up approach rather than a strategic allocation approach. We look for undervalued securities that have some inherent quality and allocate towards those securities. The industry exposure would therefore be the result rather than the explicit goal. Over and above that, we have a risk overlay to make sure that the end result of that process isn’t concentrated bets in specific industries.
How do you decide how much of each asset class to hold?
It’s very much the same process. Once again, it’s bottom-up and our default would be to say, “Let’s start in cash” and if we see securities that have some kind of inherent quality and are trading at a price below what we believe to be its intrinsic value, we would allocate to that specific security. In that way, we build up a portfolio and the asset allocation is very much the end result of that process. Once again, we don’t have a strategic or (as is known) a top-down asset class selection process. It’s all built from the bottom-up.
What about going offshore. How do you decide which portion of the portfolio to invest offshore?
Once again, the pension fund regulations stipulate that you’re only allowed a maximum of 25% offshore so naturally, we would stick to that. Even in that, you’ve got a range of zero to 25%. We would generally use the 25% allocation fully. Firstly, there are just so many opportunities in the global arena and it’s very unlikely that you can’t fill 25% of a portfolio if you’re truly looking across the universe. Again, there are the diversification benefits of not having all your eggs in one basket. South Africa is an emerging market naturally, and it’s good to get some other market exposure.
Read also: PSG Balanced Fund passes R6bn in AUM
What about investment traps and how to avoid them? What are those common investment traps?
There are specifically two, which we highlight. The first is overconfidence. Very often, investors build up a reasonable track record and then, what they tend to do is more highly correlated bets – potentially move faster than they should be moving in terms of how much work they’ve done. For us, it’s very important to stay grounded and to perform very thorough research which is put through our decision-making process We encourage rigorous internal debate to make sure that we’re thinking every opportunity through and objectively assessing portfolio correlations. The second one: quite often, portfolio managers are too far removed from the end client and they get caught up in the game of chasing peers, and so it becomes more of a competition between themselves and other portfolio managers rather than doing what’s right for the client.
We are very, very disciplined on focusing on generating real returns – returns above inflation – which is feasible for the mandate rather than holding overvalued securities just because they are held by our peers…
How do you measure the success of the Fund, apart from the fact that you’ve returned 14.7% per year, since 1999? Are there any other ways that you measure your success?
Yes. We would look at whether, during any period in time, we were exposing clients to excessive pockets of risk. For us, risk isn’t really volatility. It’s more ‘have you introduced low-quality securities’, because a low-quality business is harder to value. Have you introduced significant correlations/concentrations of risk or have you introduced overvalued securities? So pockets of exposure where prices could correct sharply. For us, risk is the second dimension to returns and those are the measures we monitor.
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— PSG Asset Management (@PSG_AM) January 26, 2017
Do you think investors properly understand the long-term cost of low-risk investment?
No. Unfortunately, I think that’s an expense, which you only realise years too late… Once the time has passed, it’s past and there’s no way of catching it up. That’s why we’re specifically being quite vocal on this… Just make sure that you’re asking properly about where your pension is being invested.
How do you educate people? It would seem that for a lot of people, the alternative to low-risk investment is high-risk investment and for them, that’s a frightening prospect. How do you persuade them that low-risk investments…? Well, you can do the numbers. You can do the math but at the same time, this element of risk might be the deterrent.
I think the first step is that you need to explain the building blocks. The first building block, which is key is equities. Very often, that’s just associated with tremendous volatility and therefore, risk. That’s the first thing that needs to be broken down – this misconception that volatility equals risk. You need to explain to people the companies, which they’re invested in… It’s much easier to give someone comfort that they’re invested in for example, Nedbank. Then that they’ve invested in the Stock Exchange because the Stock Exchange is associated with risk whereas some companies are associated with stability. Very often, we go out and remind our clients, “ You invested in these companies. They’ve got good management. They’ve got good positions in their markets. They’ve got a competitive advantage,”. Rather sell the building blocks than just using very technical terms like the equity markets.
