Issue: April/June 2010
Keep it simple, stupid
Burger...look at ultimate yield
There’s an obvious way for trustees to add value, suggests Libfin head of investment strategy ROWAN BURGER. It’s not in creation of ever-more complex structures but in encouraging fund members not to be tempted into premature grabs for cash.
Out of 17 000 exits from retirement funds under its administration, a life insurer has found that only 83 members chose to preserve their benefits. This is an indictment on how the nation’s retirement savings are constructed.
Much is said about how costs erode retirement benefits. One must then wonder whether trustees are correctly focused. What’s the point of incurring huge expenses in managing the matters of a retirement fund when all value is destroyed?
Trustees are lectured to avoid conflicts of interest. The insurance company runs its administration function with the intention of a second-order benefit to capture the assets of exiting members in retirement annuity and preservation policies. Considering this conflict, trustees may well have resisted attempts by the administrator to educate members on the need to preserve benefits. But here is a clear case of far higher preservation being in both the industry’s and the insurance company’s shareholders’ interest.
Trustees feel the need to add value. While they play a key role in ensuring the appropriate customisation of service to their group of members, and use their size to drive cost efficiencies, in many cases there is a conflicting incentive for service providers to maximize their revenue from their small mandate. To do this, consultants construct elaborate tiers of asset managers who’ll try to achieve an investment strategy. In many cases these asset consultants do not have the sophisticated tools to allocate investments efficiently between the various tiers.
The key to effective investment management is being able to move quickly on opportunities as they arise. A cumbersome decision-making process with trustees means that it can take too long to react. To resolve this structural flaw, they usurp the asset management role and introduce implemented consulting.
Many trustees try to manage away from conflicts of interest. Since trusteeship is largely a part-time, unpaid occupation, the prevailing approach seems to be to hire a multitude of experts to keep their peers on the straight and narrow. Since there is no incentive to innovate as your competitors immediately review your ideas, it is no wonder there have been few significant advances in the industry over the past decade. But the overlapping of duties and complexities of mediating between rivals leads to additional time and resources.
Unfortunately, it is difficult to determine whether there is truly value-add by creation of tiered assetstrategy solutions and similarly complicated structures. There are no longer comparable peer surveys of fund returns. This is justifiable given the heterogeneous nature of fund demographics. However, it would be useful to get a sense of whether the consultant’s process adds value relative to the general market approach.
Many implemented consultants use their purchasing power to force managers to cut their fees. This discount to some extent funds the consulting service. It means the managers must look to earn their margin in other areas.
Other areas of their business are then more expensive. Or they devise more creative ways of charging, such as the introduction of performance fees. The concern with favourable fee arrangements is that they may often conflict the consultant when considering if the termination of the manager is appropriate.
It is not appropriate for investors to be exposed to one asset class, manager or strategy. Some element of complexity must exist. At what point do trustees, and by extension members, overpay for complexity which does not deliver returns?
The real problem is that these complex structures cannot be understood and replicated by members with their private savings. No wonder they abdicate and simply take their savings in cash.
Surely trustees should focus on creating structures that facilitate the continuation of the retirement savings process once members leave funds and their stewardship? Simpler structures would also assist in the understanding of key investment principles such as seeking inflation-beating returns and diversification.
YIELD REDUCTION BY EXAMPLE
Take a 25-year old who maintains a reasonable savings trajectory. If he decides after 10 years’ service to encash his savings and then resume saving at the same rate, the effective end-pension is nearly half what it should have been. Why is there not outrage from trustees at this value destruction of 50% in yield?
Equally, there is a large yield reduction if a member selects a portfolio on the basis of trying to be conservative rather than achieving a required investment return. A smooth-bonus portfolio with a more conservative investment strategy and high capital charge can easily result in a yield reduction of 50% over full membership of a fund. However, there is a great deal of comfort for trustees who over their short stewardship can claim that there has not been a capital loss.
Getting involved in complex investment strategies with a multitude of service providers is far more stimulating than mundane communication and education of members. It would be much more valuable if important cost metrics were applied to areas where trustees have the most influence and were accountable for them.