Edition: Dec 2013- Feb 2014

Enhanced investment solutions

The present environment combines needs with opportunities, believes De Wet van der Spuy of Liberty Corporate.

Against the backdrop of volatile markets, evolving regulation and the rising cost of living, the right decisions on retirement planning become increasingly important.

This has prompted widespread reconsideration of investment strategy and a subsequent shift within the SA industry towards consolidation of retirement funds. Change is being driven by government (through retirement-reform proposals) and by the industry (as service providers seeking to align with the changes and stay competitive).

Over the past seven years, there’s been a 33% decline in the number of funds registered by the Financial Services Board. This compares with a 100% increase in participating employers of Liberty Corporate’s umbrella fund, the largest industry umbrella fund measured by participating employers and members.

A major benefit of the consolidation into umbrellas is improved governance. Employers and members receive unrestricted access to professional and experienced trustees that they may not have had in a standalone fund. Using a wellgoverned umbrella fund simplifies an employer’s operations, providing more time and resource to focus on core business activities.

Employers can also enjoy significantly increased efficiencies. Umbrella funds provide economies of scale, hence lower administrative and investment costs. A large fund has much greater negotiating power to reduce fees and overall administration costs.

For members, consolidation offers greater cost benefits and in many cases extended investment choice options. Also, members pay only for what they choose; those members who select a trustee default investment option are likely to pay lower costs.

Another significant focus is on appropriate default investment options. Treasury’s proposals suggest that introducing default investment options into retirement funds could have numerous advantages, such as allowing passive investment to play a bigger role and so to reduce costs. A well-developed default solution will also enable elimination of unnecessary guarantees as well as the removal or avoidance of performance fees.

This default solution not only protects members from making poor investment decisions but also has significant cost benefits for employers and service providers.

There is a great deal of bias in the system. Default solutions help to address this pitfall without individual members having to think about it. Most people who make decisions themselves invest too conservatively.

Through a default life-stage solution, this problem is automatically overcome as it allows for a more aggressive investment strategy for younger members that gradually shifts towards a more conservative and protected strategy for members nearing retirement. But a financially- savvy member with specific needs has the option to switch out of the default into his or her chosen investment portfolio at any time.

A most important consideration in assessing a default option is to analyse the investment component over and above the choice of administrator. The advantages of making the right choices on investment component and strategy for one’s member profile far outweigh those of selecting the cheapest administrator.

The chart below shows that a standard default solution (with a CPI +5% per annum return target and administration fee of R30 per member per month) still provides a 20% higher retirement benefit than a default solution that carries an unnecessary guarantee charge of 1% per annum for which administration fees have been discounted by 50% (to R15 per member per month).