When it comes to investing, we often get told not to try time the market. However, timing can be vital with things like retirement. In retirement, early market declines, particularly if they are paired with rising inflation, can have a huge effect on how long one’s retirement savings can sustain a retiree. In this article we’ll offer examples that illustrate sequence of returns risk in order to better understand how it can affect a retirement portfolio and how the 36ONE Hedge Fund can help minimise sequence of returns risk.
The risk involved in withdrawing from a volatile portfolio – termed sequence-of-return-risk – is lower when portfolio volatility is lower. The best way to think about this is if the value of your retirement savings declines near the outset of drawing an income, the amount withdrawn will represent a bigger portion of your investment than if you had experienced growth over the same period. The effect of this is that the capital continues to decline with each additional income withdrawal, leaving less capital to grow. This could result in retirement savings running out much sooner than if the portfolio experienced positive returns at the start of the withdrawal period.
To better understand the sequence of returns risk, let’s examine two scenarios:
Consider a hypothetical portfolio valued at R1 000 000 at inception. We start investing in April 2006 (which is the launch date of the 36ONE SNN QI Hedge Fund) with a single lump sum investment and neither add to it nor withdraw from it during the ~16 year period. The chart below summarises what the investment portfolio would be worth on 31 August 2022 in nominal terms, compared to the same investment made into the FTSE/JSE All Share Total Return Index:
The investor would have been substantially better off if she/he had invested the full lump sum amount in the 36ONE SNN QI Hedge Fund, which does not come as a surprise as the hedge fund has outperformed the FTSE/JSE All Share Index by 5.2% per year (after fees) over the period April 2006 – August 2022.
The outcome looks very different if you were to regularly withdraw from the portfolios. In the second scenario below, we observe a hypothetical portfolio valued at R1 000 000 at inception and assume that an annual income of 4.5% p.a. is withdrawn monthly (escalating annually at 6% p.a.).
The chart below summarises what the investment portfolio would be worth on 31 August 2022 in nominal terms, compared to the same investment and withdrawals made from the FTSE/JSE All Share Total Return Index:
When we compare the end values of the income producing portfolios above (scenario 2), the 36ONE SNN QI Hedge Fund outperformed the FTSE/JSE All Share Index by 6.7% p.a. In this scenario, the end portfolio value is 172% higher when investing in our hedge fund, in comparison to the FTSE/JSE All Share Index. This is substantially higher than the lump sum scenario (scenario 1) initially depicted, where the 36ONE SNN QI Hedge Fund outperformed the FTSE/JSE All Share Index by 5.2% p.a., resulting in a portfolio end value that was 112% higher.
That’s a sizeable gap in outcomes — the difference is the very essence of sequence of return risk. For investors who need to draw from their investments regularly, like those with living annuities, volatility becomes crucially important.
Over the ~16 year period (April 2006 to August 2022) the volatility of the 36ONE SNN QI Hedge Fund was substantially lower than that of the FTSE/JSE All Share Index. Furthermore the hedge fund experienced much lower drawdowns during the period. The return profile of the hedge fund was substantially more stable than the market over the time period, which resulted in a much better outcome for the portfolio invested in the hedge fund.
| Volatility p.a. | Max Drawdown Since Inception |
Max Drawdown 3 Years |
|
|---|---|---|---|
| 36ONE Hedge Fund | 8.4% | -12.59% | -3.4% |
| ALSI | 16.1% | -40.44% | -21.7% |
While the above scenarios are simplified and don’t take tax and other related investment costs into account, the point is rather to illustrate just how important the consideration of volatility is for clients invested in income producing portfolios.
Withdrawing assets in a down market during the early years of retirement is one of the biggest risks to portfolio longevity. When the market recovers, the portfolio may not have as much room to grow (longevity) because it has been depleted by ongoing withdrawals. Higher volatility can act as a drag on performance in income producing portfolios and can result in investors not meeting their income objectives over the lifespan of their retirement.
We believe the 36ONE hedge funds are an appropriate solution. By virtue of the strategies and instruments that we use, we have the ability to participate not only in up markets, but can also protect capital during down markets.
Our hedge funds can form a very useful part of an investment portfolio, as they have the potential to provide investors with returns that are similar to an equity mandate, but with much lower levels of volatility and much lower drawdowns resulting in better risk-adjusted returns. We believe it is a fantastic compliment to a well-diversified portfolio. The fund can reduce the sequence-of-return-risk, without compromising on longer-term growth.
The 36ONE SNN Retail Hedge Fund is now available on most major LISP platforms. If you aren’t already considering the benefits of this strategy within your or your clients’ portfolios, we suggest you get in touch.
As a reminder, the 36ONE SNN Retail Hedge Fund can now be accessed on the following LISP platforms:
- Ninety One
- Allan Gray (available on their restricted fund list)
- Momentum Wealth
- Glacier
- Stanlib
- AIMS
- Wealthport
Disclaimer:
The information presented here is not intended to be relied upon for investment advice. Various assumptions were made.
Source: Bloomberg, Sanne, 36ONE Research; Performance to 31 August 2022.
Past Performance is not necessarily an indication of future performance. 36ONE SNN QIHF CISCA inception date is 01 November 2016. Sanne Management Company is registered and approved by the FSCA under CISCA and retains full legal responsibility for the third-party-named portfolio. 36ONE QIHF Highest and lowest rolling 12-month performance since inception: High 58.63%; Low -10.84%. Full mandatory disclosures can be obtained on our website by following this link: https://www.36one.co.za/legal/disclaimer. 36ONE Asset Management Pty Ltd is a licensed financial service provider. FSP# 19107