While it is important to provide return information to members, it equally important to communicate to members that the expected returns from their investments are a result of exposing their savings to some level of risk which is most often in the form of volatility of the markets – in that prices rise and fall in the short-term, but generally grow well over the fullness of time.
This volatility in values of investments is often called risk and makes members uncomfortable. It can lead some to shy away from what is deemed risky assets such as shares and to invest more conservatively in cash or bond type instruments. Unfortunately, this is a poor long-term strategy and will result in member’s fund credits being lower in the long-term than what they would be, if they adopted the right strategy of investing in the riskier assets for maximum growth. Fortunately pension funds have boards of trustees and advisors who help set the strategy and keep the fund credits of members on the right growth path with the right levels of risk.
Economic performance around the world
|REGION||GDP Growth rate||Inflation||Interest Rates|
|Botswana||8.4% (Sep-21)||10.6% (Jan-22)||3.75% (Feb-22)|
|USA||5.6% (Dec-21)||7.5% (Jan-22)||0.25% (Feb-22)|
|Eurozone||4.6% (Dec-21)||5.8% (Feb-22)||0.0% (Feb-22)|
|UK||6.5% (Dec-21)||5.5% (Jan-22)||0.5% (Feb-22)|
|China||4.0% (Dec-21)||0.9% (Feb-22)||3.7% (Mar-22)|
Below are some of the main investment risks that pension funds face as they invest members savings in the market. Pension funds do take measures to guard against; mitigate or give some level of protection against these risks.
Market and Volatility risk: Risk of a reduction in value due to adverse movements in asset markets locally or offshore. The loss in value is usually temporary but can take time to recover. Macro-economic and political factors as well as unexpected risk events contribute to this risk category. Equity markets are affected by movements in the interest rate cycle and currency rates, among other factors. Other asset classes like Bonds, Property and Cash are highly affected by interest rate movements.
Volatility risk is associated with short term movements (up or down) in the price of different asset classes as a result of changes in investor sentiment and expectations, even where the underlying fundamental value of the assets remain unchanged.
Standard mitigation factors of market and volatility risk: Diversification by country/region/industry/legal jurisdiction and across a wide range of asset classes. Diversification by using more than one asset manager to implement the Fund’s investment strategy because asset managers are usually skilled in managing risk, not to avoid it. Additional diversification can be achieved by using different investment styles and strategies.
Inflation risk: This is where the value of capital grows at a rate lower that the rate at which the cost of goods and services is growing, resulting in an erosion of the capital to fund the required pensions for members when they retire.
Standard mitigation factors of inflation risk: The way in which the fund chooses to combine different asset classes should be such that in the medium to long term, the returns generated from that combination of markets should yield more that the rate of cost of living.
Governance Risk: This risk relates to potential conflicts of interests, biases or inappropriate fund decisions, fraud, misallocation of assets, as well as inadequate fund objectives and strategies as well as other aspects of poor fund governance by the fund’s decision-makers.
How have financial markets performed over the last 12 months to December 2021?
|1 Year Botswana Local shares (TR)||1 Year Botswana Local Bond Performance (Fleming Bond Index)||1 Year money market (BWP) (Overnight Call rate +2%)||1 Year MSCI ACWI (BWP)||1 Year MSCI Emerging Markets||1 Year change Botswana Pula vs US$|
Standard mitigation factors of governance risk: Adherence to the laws and regulations set by the regulator. Fund decision makers should also ensure that different processes are in place to address any conflict of interest or even combat any type of fraud, such a segregation of duties. Operational risk management system; Fund Risk Matrix; Risk Management Policy & Board Code of Conduct, a checklist (record) for decisions taken are crucial in aligning the governance procedures.
This corporate governance, risk management, internal controls and Code of Conduct should be ratified by external auditors to minimise the possibility of decision makers leaving gaps for things to go wrong in the future. These policies should be periodically reviewed to check for their relevance in the evolving environment, they should also be reviewed together with information processes, operational software systems and accounting and financial reporting, internal audit and compliance.
Decision makers should have internal and external control mechanisms for checking compliance, verification and reconciliation as well as appropriate reporting mechanisms for receiving information and reporting to the regulatory authorities, but most importantly communication to members of the fund as they are the beneficial owners of the funds.
Botswana Retirement Fund Column is sponsored by Strategic Wealth
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DISCLAIMER: While every effort is taken to ensure the accuracy of the information used in this column, Strategic Wealth accepts no liability for errors or omissions. Information is provided for general educational purposes and is not to be treated as financial advice. Investors should consult professional advisors before taking any action. Not all statements necessarily reflect the views of Strategic Wealth.