Historically, medical aid inflation has been much higher than consumer price inflation and is currently close to 11% compared with CPI at 6%.
The fact that Regulations 29 and 30 of the Medical Schemes Act limit equity exposure to a maximum of 40% makes high return targets challenging to achieve, said Bastian Teichgreeber, Portfolio Manager at Prescient Investment Management.
“This is especially so considering the high liquidity needs of medical aid schemes for funding necessary withdrawals,” he added.
Generally speaking, Prescient expects equities to deliver real long-term returns in a range of 6% to 8%, bonds to achieve 2% real growth, and cash 1% real growth.
Teichgreeber noted, however, that it is possible to achieve an ambitious investment return target while being sensitive to the risk of losses, and while working within the constraints of legislation in a highly regulated environment.
“At Prescient we believe in the concept of compounding positive returns over time and therefore we do not think it is contradictory to have an ambitious return target while at the same being sensitive to downside risk.
“We achieve this by holding a significant portion in growth assets which are protected from any risk of losing capital.
“Our philosophy is centred around capital preservation as we structure solutions that are able to capture the market as it goes up, without exposing our clients to loss of value as markets go down”.
Teichgreeber said that Prescient manages its medical aid solution in a way that delivers returns significantly above medical aid inflation, after fees.
Given the high liquidity needs of medical aid funds, a large allocation of a fund’s capital is allocated to interest bearing assets. At Prescient this necessitates a thorough analysis of interest bearing instruments, which is undertaken on an ongoing basis as part of the group’s robust credit process.
The challenge for medical aid funds is to deliver inflation-beating returns while dealing with tough liquidity and regulatory constraints, and a low tolerance to take on risk.
According to Teichgreeber: “By protecting our equity allocation, we are able to carry a higher portion in the important inflation-beating asset class than ordinary allocations. Regulation 29 allows a medical aid scheme to carry a higher nominal equity exposure, as long as the fund manager buys protection on it.
“By doing so we are not only Regulation 29 compliant, we also reduce the portfolio’s downside risk while enabling it to capture the necessary equity upside.
“With our long track record in running derivative driven funds, we are the ideal partner for any medical aid scheme. We know how to manage protected equity in a balanced portfolio and how to make sure that the protection is not a drag on performance.
“On top of that, as one of the leading fixed income houses in South Africa, we know how to deal with the remaining, more conservative allocation of the portfolio”.
In terms of historical performance, Prescient has proven its ability to manage downside risks efficiently over almost two decades, adhering to its promise not to lose capital. Despite not losing any capital, the group has delivered significant equity upside.
Since inception of its Positive Return Strategy in 1998, Prescient has returned CPI plus 7% without any downside risk.