Alexander Forbes: SA retirement industry investment focus ‘outdated and one-dimensional’

At a media briefing in Johannesburg today, Alexander Forbes noted that the South African retirement fund industry’s focus on only asset performance was ‘outdated and one - dimensional’ placing pensioners at a greater risk of a cash-starved retirement.

Trevor Abromowitz, Head of Asset Consultants at Alexander Forbes Financial Services, said that defined benefit pension funds in South Africa have traditionally focused on the returns of their assets and should in future give their liabilities just as much attention.

“The approach of investing in assets as a priority and hoping they will accumulate sufficiently to pay pensions is one dimensional.

“Funds need to first look at their liabilities – essentially their obligations to members and pensioners – and then decide on the appropriate investment strategy to meet these liabilities. This is called a Liability Driven Investment (LDI) approach and places the pension liabilities at the heart of the investment decision.”

He notes that too many South African pension funds have taken the ‘invest and hope’ tack which is placing funds in the position of not being able to pay out as much as pensioners expect, jeopardizing their ambitions of securing a comfortable retirement .

Jos Vermeulen, Head of Special Projects at Alexander Forbes Financial Services said: “This has left funds in trouble because they have pension liabilities that far outstrip the value of their assets.

“It makes no sense to simply invest in a traditional portfolio of shares, bonds and cash when meeting the liability of the fund is the most important objective.

“Furthermore, there is the ever increasing risk that stems from the advances in medical technology called longevity risk: the risk that people live a long time and run out of money.” International studies show that life expectancy has increased by 3 months per year over the last 150 years.

“It makes sense for South African retirement funds to consider a new, more sophisticated approach. This approach should allow trustees to understand the risks embedded in their investment portfolios and only take enough risk to meet their fund’s liabilities,” Vermeulen added.

“For example, if a fund has enough assets to meet its liabilities, why should it not scale down and deliver its pension obligations with greater certainty?”

Alexander Forbes is launching LDI funds this week, a first in South Africa, to help retirement funds and individuals better align assets and liabilities.

Vermeulen noted: “Funds should consider reducing the risks they face by locking in returns and removing longevity risk using more appropriate investments. Historically retirement funds haven’t done this; their strategies have not taken into account the gap between assets and liabilities.”

Abromowitz advised retirement funds to ‘immunize’ their obligations so that liabilities are at all times matched with the assets and are therefore not at the mercy of changes in interest rates and inflation, two of the biggest threats to the value of retirement fund liabilities.

“When a portfolio is immunized, it is structured in such a way that its value – relative to the fund’s liabilities – stays steady despite changes in interest rates and inflation.

“This will give it a far greater chance of meeting its pension obligations.”