Issue: September 2012 / November 2012
Editorials

RETIREMENT SAVINGS

Damocles’ sword

Cut costs, says National Treasury. What it wants, it will get one way or another. Preferably without competing against the private sector.


Gluckman and McCarthy...common ground

An intriguing dynamic has developed in the exchanges between financial-service providers and National Treasury over reform of retirement funds. The whiff of it came from an off-the-cuff remark by David Gluckman, Sanlam Employee Benefits head of research, at the latest Sanlam benchmark symposium.

Sounding off on the growth of umbrella funds and how they were able to reduce costs, he turned with a wry smile to ask David McCarthy of National Treasury whether he’d noted how the ‘sword of Damocles’ was working. For it’s McCarthy, the retirement-policy specialist, who bangs on about product costs. McCarthy smiled back.

The sword is double-edged, both intimidating. One edge is for National Treasury to introduce savings products cheaper and simpler than those presently on offer. The other is the mooted National Social Security Fund, with a savings pillar similarly threatening to deprive financial institutions of significant business.

The value of the sword is in its waving, not its stabbing, because it’s caused what Gluckman calls “positive passive reform”. As it proceeds with offerings that government wants, so the need for government intervention obviates. The industry can then get on with ways to improve savings levels and government with providing regulatory certainty. It’s not yet a marriage made in heaven, but there is a constructive engagement.

According to the 2012 Sanlam benchmark research, members of large funds save nearly one percentage point more of their salaries towards retirement than members of smaller funds. The latter pay nearly twice as much in administration and operating fees (1,24% of salary) than members of large umbrella funds (0,56% of salary).

In the past year alone, a quarter of all retirement-fund members moved into umbrellas. There are now 26 major commercial umbrella funds, backed by nine sponsoring companies, whose total assets are estimated to have grown in a year from R88bn to R110bn and the number of members from 1,13m to 1,50m.

“We expect more product simplification, standardisation of the cost regime and further tax efficiencies as the retirement-fund landscape continues to evolve rapidly,” says Danie van Zyl of Sanlam Structured Solutions.

When talking fees and costs, the odd 1% here and there sounds tiny. But its impact is massive. If costs can be reduced to allow just 1% of the monthly contributions to be redirected to retirement funding from overhead costs, the survey points out, the retirement benefit can be increased by around 5% over 35 years.

In his presentation, McCarthy analysed respective reductions in yield (see tables). RiY is a figure given for the effect of the total charges applied to an investment policy, enabling cost comparisons of one policy with another.

He set out the bad arguments justifying RiY:

  • Possibility of manager outperformance. Most active managers do not outperform appropriately-chosen benchmarks. Persistent active outperformance posits not market inefficiency but the existence of large classes of investors who consistently underperform;
  • ‘Volatility management’. Market timing is perhaps even tougher than stock selection. Short-term guarantees/smoothing are unsuitable for long-term investors;
  • Necessity of distribution. Is there a better way than conventional practice?
  • Providing ‘comfort’. Risk-averse investors would probably be better off in low-cost low-risk portfolios than in structured high-risk portfolios. Short-term volatility is the source of long-term expected returns, so a cost-effective choice must be made.

What then are the drivers of high charges? According to McCarthy:

  • SA has relied almost entirely on market mechanisms to design products, charging structures and fees levels;
  • Many retirement products have multiple layers of charges (such as administration and investment management charges as well as advisor and performance fees), causing difficulty in making comparisons across products and channels;
  • Costs of investment management, in particular, are high;
  • Passive investment management, which is significantly cheaper and not demonstrably inferior to active management over the long term, is underutilised;
  • Distribution channels may encourage conflicts of interest between financial advisors and their clients in wholesale and retail markets.

There you have it, succinctly put. The industry knows precisely the challenges from National Treasury and is certainly, in its own interests, making strenuous efforts to meet them. First prize is that they be so comprehensively met – by innovation of cheaper and simpler products that provide default options requiring, for instance, minimal reliance on intermediaries – that the sword of Damocles is returned to its sheath.

For all the promise of umbrellas, amongst other outstanding issues is the stimulation of retirement savings especially for lower-paid workers. Equally critical is the availability of post-retirement products that, by taking the knife to fees and charges, can lessen the reductions in annuity payouts. Service providers, upholders of the market mechanism, are in a race against time.