Regulator to shine a light on value for money in our retirement savings

Costs, fees and inefficiencies can erode savings significantly when you are saving over a long period for a goal such as your retirement – particularly if you do not engage with your retirement fund or do not understand how your savings are invested.

The regulator of retirement funds, the Financial Sector Conduct Authority, plans therefore to develop a simpler way for funds and members to determine whether the costs paid justify the overall value delivered to members over long terms, Zareena Camroodien, the FSCA divisional executive for retirement funds supervision, told the Institute of Retirement Funds conference held in Cape Town last week.

She said the FSCA then would regularly publish easy-to-understand data on retirement funds investment performance relative to benchmarks, peers and standard portfolios, costs and charges, quality of service and suitability.

The FSCA would make use of cost measures already used in South Africa, including return on investment (ROI) and the total expense ratio (TER) and would ensure that comparisons are across comparable funds, for example, within umbrella funds or within standalone funds, Camroodien said.

The FSCA efforts are supported by an International Organisation of Pension Supervisors (IOPS) project.

This project recognises that the shift from defined benefit to defined contribution retirement funds means that members now bear investment, longevity and decision-making risks. It aims to help retirement fund supervisors around the world improve the retirement savings outcomes for members by ensuring funds are transparent, comparable and efficient.

Camroodien said similar initiatives in Australia, the UK, Hong Kong, China and Mexico used caps on the maximum fees, governance requirements, disclosure rules, consumer protection and investment rules to ensure that pension schemes deliver good value relative to their costs and risks.

Make fees understandable

Subedra Reddy, executive head of actuarial services at NBC, urged trustees and other retirement industry professionals attending the IRFA conference to come up with a new way of charging fees so that trustees and members can understand what fees they will pay in a year, in five years and 40 years’ time.

Reddy said fee calculations can be complex and fees are often hidden and not always apparent on financial statements.

The way in which fees are charged and how they will grow over time makes a big difference, and we can’t always work out how much the fees will be, Reddy said.

Three different ways in which fees can be charged include:

1. A rand amount per month
2. A percentage of assets and
3. A percentage of salaries.

Reddy said the costs of saving in a retirement fund should be like buying bread − you want to know the price before you buy and you don’t want to use a spreadsheet to work out how much you will pay.

You don't want to be told how much bread costs per slice or per gram. You also don’t want to pay based on how much flour goes into the bread or per carbohydrate in it, Reddy said.

Look beyond where costs begin

Reddy cautioned trustees and members against considering the starting fee only.

He cited the example of a fund with R1.4 million invested on behalf of 5 200 members who earn R900 million in total salaries.

The fund will pay R6.2 million a year in fees if it pays fees of:

• R100 rand per member per month
• 44 percent of the amount invested (assets under management) or
• 69 percent of salaries.

But thereafter, the rand per member fee would increase with inflation only while the other fees would increase with salary inflation – typically slightly more than inflation - or the investment return, which could be anything from a negative return to 30 percent a year, Reddy said.

The fund may even return less than a benchmark like the All Share (Alsi) index – for example 20 percent when the Alsi returns 25 percent, but the fee on assets invested would increase by 20 percent. It doesn't make sense, Reddy said.

Fees based on savings grow faster

Over time, the fees as percentage of assets fee will be as much as five times the difference in fees that increase with inflation. Over 40 years, for example, if the fixed fee per month increased to R10 million, the fee on the percentage of assets will go up to R50 million, Reddy said.

Members and trustees have to consider what they pay in fees in a year's time, five years time, and 40 years’ time.

A fee based on assets favours a new member who has just joined a fund and has not built up any savings. For the first 25 years of your working life, fees charged in these three different ways may be quite similar, but over time the asset-based fee would be double the fees based on inflation or salary inflation, and members paying different fees will retire with very different outcomes, Reddy said.

He urged the industry to ensure fees are simple, understandable and reasonable, and service providers do not get rich at members’ expense.

Find the best outcome for all members

The choice of investments in a retirement fund is also very important when it comes to ensuring you get value for money.

In his presentation at the IRFA conference, Jannie Leach, head of core of Investments at Nedgroup Investments, warned members and retirement fund trustees against chasing returns delivered by top-performing managers.

He said trustees should look for consistency of performance and reliable outcomes for members at different stages of their saving journey, as members may experience the same portfolio differently depending on whether they are a long-serving member with a large accumulated balance or a new member building up savings gradually through monthly contributions.

Members also enter, transfer or retire at different times resulting in them experiencing only part of the performance cycle of any fund manager who is managing the retirement savings.

The risk of timing manager switches poorly

Trustees often diversify across different managers but this increases the risk of hiring and firing managers at the wrong time.

Leach said evidence from thousands of pension-fund decisions showed that managers were commonly appointed after strong three-year performances and dismissed after weakness, only for the dismissed managers to outperform the newly hired managers over the following three years.

A money-weighted analysis of major South African multi-asset funds showed that investors’ actual returns lagged equivalent lump-sum fund returns by about four percentage points a year on average, Leach said.

Leach said a member investing monthly over ten years earned, on average, about 1.2 percentage points a year less than someone who invested a large sum at the outset, simply because less money was exposed to early market growth.

This means that around three percent of the difference in returns is probably a result of poorly timed investment in yesterday’s winning managers and withdrawals from tomorrow’s winning managers, he said.

Leach said this analysis showed that it was safer to construct portfolios with a low-cost, diversified index as the core as it is transparent and dependable and low cost. Active managers who have proven that they can consistently make small repeatable gains rather than larger but infrequent returns, could then be added to make up 25 to 30 percent of the portfolio.

In future, members will hopefully be able to see for themselves in the data published by the FSCA which funds’ investment strategies and their related fees, deliver value-for-money.