Issue: Sep - Nov 2013
FUND COSTS DEBATE
More to consider
One is risk premiums. Another is administration. There should be a sharper focus on these elements too.
A question pertinently asked at the Principal Officers Association winter conference by Erich Kröhnert, head of strategy and research at Momentum Retirement Administrators, is whether National Treasury’s discussion paper goes sufficiently far to address all pertinent costs in SA’s retirement industry.
Broadly-speaking, he points out, there are three cost drivers: administration, investment and risk. But risk premiums are often excluded as a cost in pricing models as most consultants believe that this is insurance, not a layer of cost.
Nevertheless, risk premiums generally represent a reduction in the allocation to members of retirement savings. This means that any over-insurance or inappropriate insurance represents an undue reduction in retirement savings. It’s therefore important to look at all factors that cause reductions.
The accompanying graph illustrates the administration, risk and investment costs that a member would theoretically pay on a month-by-month basis if he were a member of the same fund throughout his 40-year employment career.
While administration expenses and risk premiums generally increase in line with inflation, investment fees increase exponentially as the accumulated savings increase with contributions and investment returns. In the 480th month of a person’s membership (40 years after the individual began contributing to the fund), the investment fee is almost nine times the administration fee and 2,7 times the risk premiums.
This may lead to some uncomfortable questions about the way in which investment fees are levied. Possibly even more unsettling is that the illustration uses an investment fee at 1% of assets, a percentage that’s perhaps unreasonably low partly because it excludes the effects of performance-based fees. He asks what might be done in the absence of regulatory intervention.
This is because there doesn’t seem to be an obvious connection between the long-term savings nature of a retirement fund and investment management fees that reward the manager for outperformance over a short or medium term. Industry architects and trustees must start focusing on adequate sustainable long-term returns instead of outperformance in the short term, he urges.
The analysis also reveals that risk costs, which were largely ignored in Treasury’s paper, should be revisited. There appears to be a need to investigate appropriate and adequate insurance cover.
Although administration fees are proportionately the lowest category of costs incurred by funds, Treasury alluded to administration indirectly being a large determinant of overall fund costs. Its paper appears to indicate that a standalone fund (with scale) that uses an administrator of standalones, distinct from multi-employer umbrellas, is the most effective way to keep fund costs down.
Apart from playing an oversight role in the provision of other services to funds, a standalone fund’s administrator should theoretically work with trustees and consultants in analysing both fund and member behaviour with a view to meeting fund objectives, minimising yield reduction and helping trustees fulfil their fiduciary duties.
Treasury implies that the ability for funds to move between administrators is something that trustees can use to improve overall governance (and reduce costs). However, portability has always been an issue in SA. It helps explains why, despite some administrators being involved
Kröhnert argues that the ceiling should be raised significantly: “Perhaps there needs to be a consolidation of administrators so that those which remain not only have scale but also comply with the strictest quality standards as, for example, in ISAE 3402.”
Treasury’s paper is merely the start of the discussion, he suggests: “To significantly reduce costs will possibly necessitate structural change for some of the country’s biggest retirement-fund service providers or even of the industry itself.”