Issue: June 2012 / August 2012
Expert Opinion

Role of trustees

So important are their investment decisions, especially in the defined-contribution environment and with a mind to the new Reg 28, that they shouldn’t be shy to seek independent advice. The reasons are outlined by Andrew Kemp, head of investment strategies at Liberty Corporate.

Kemp...what to watch
Kemp...what to watch
Over the past 20 years the South African retirement fund landscape has increasingly moved towards a defined-contribution system, and away from the more paternalistic defined-benefit system.

Under the defined-benefit system, members of a retirement fund enjoyed benefits upon retirement whose value was defined in advance. A consequence was that the risk of providing these benefits sat with the employer.

Under a defined-contribution framework, the contribution rates for the members and employers are defined, but the end benefit is not. It means that individual members bear the risk that their investments do not provide the returns necessary to ensure a comfortable retirement.

In this regard, trustees face a number of difficulties in fulfilling their duties. Often it is crucial that they approach experts to assist in discharging these responsibilities.

Trustees are responsible for the operation of the fund, and owe a fiduciary responsibility to the fund’s members. Trustees are responsible for ensuring that the benefit design of the fund is appropriate for the members, as well as ensuring that the fund’s investment strategy takes account of the needs of the membership, and is implemented appropriately.

In a defined-contribution environment this is a significant challenge as trustees are no longer stewards of a large pool of money with one overall investment objective. Rather, trustees are in the position of determining the needs of a wide variety of members and judging how best to meet these sometimes conflicting needs.

In addition, the recent revision of Regulation 28 of the Pension Funds Act now puts great emphasis on trustees applying their minds to the specific requirements of their fund and ensuring that investment strategies are appropriate.

To do this, trustees need to understand their fund’s membership. Here is a short and certainly not exhaustive list of issues to consider:

  • Time to retirement;
  • Current share of fund;
  • Current salary;
  • Level of financial sophistication and investment knowledge;
  • Ratio of pensionable salary to total cost-to-company;
  • Net contribution rates to retirement savings.

Many trustees assume their responsibilities without formal training in investment theory and often lack the knowledge, experience and/or time to adequately investigate these issues. They should seek independent, expert advice where possible.

Generally, the two main areas here would be in ensuring an appropriate benefit design, and an appropriate investment strategy. These are two very different skill sets and trustees should ensure that they appoint experts in both fields to assist them.

Once the membership is well understood, members can be clustered according to similar risk/return requirements. Investment strategies can then be developed to meet the requirements of these individual groups.

Regulation 28 also requires trustees to develop policies to manage the investments in accordance with principles outlined by the Regulation. Again, this is a situation where many trustee boards will be best served to obtain expert advice, as some of these deal with highly technical issues.

As an example, a number of principles raised in Regulation 28 deal with the due diligence of investments. Typically, this is a field which is both time consuming and requires expert knowledge.

Of course, it is important to remember that trustees can never outsource their obligations to members. The advice they seek does not absolve them of their responsibilities and they will remain responsible for the decisions they take irrespective of whether or not they utilise expert advice.

So it is vital that trustees carefully consider what the expert is proposing, and make sure they understand the issues as thoroughly as possible.

If necessary, trustees can consider getting a second opinion or explanation if they are unsure of what a particular advisor is advising them. They should always try to improve their knowledge of pension fund matters in general, and investments in particular.

Trustees have an extremely difficult task with very onerous requirements, and so should seek appropriate assistance where necessary. Having said that, trustees must also be aware that they are ultimately responsible for the fund. They must therefore ensure that they properly understand what the advisor is saying and the implications of the decisions being made.