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Playing a dangerous game

25 September 2019 Jonathan Faurie

When it comes to saving for retirement, the biggest detractor of value is cost.

There are two very distinct sides to this debate, and both make valuable points. On the one hand, there is the argument that it is simply becoming too costly to save for retirement as the line in the sand when it comes to the acceptability of costs has been crossed long ago. The other argument in the industry is that while costs are high, retirees are paying for what they get and that some of these costs simply cannot be wished away. 

In an effort to get to the middle of the cost debate, the Financial Sector Conduct Authority (FSCA) held a panel discussion at its recently held inaugural Retirement Conference where industry experts shared their opinions on the issue. 

Fiduciary duty

In many respects, South African fund managers often find themselves caught between a rock and a hard place when it comes to managing costs. 

Mabatho Seeiso, an Independent Consultant within the financial services industry, points out that in order to understand the current predicament that fund managers find themselves in, retirees need to appreciate the duality of the role that they play. “According to their fiduciary duty, fund managers are compelled to safeguard the investment of retirees as it is often the only savings that they have. They are also compelled to grow this pot of cash as much as possible so that retirees can have the best chance of retiring comfortably. This is a complex task and requires a lot of skills and expertise. None of these come cheap,” says Seesio. 

This is not to say that South African fund managers are standing back and letting costs rise at uncontrolled rates; they are making a concerted effort to cut costs where they can, but Seeiso pointed out that South Africa is behind global benchmarks when it comes to this. 

It is currently one-nil in favor of the existence of high costs vs the desire to drive them down. At the end of the day, no retiree wants sub-optimal returns because of compromising on skills and expertise. The best skills come at a price. 

Why costs matter

Steven Nathan, Founder of 10X Investments, believes that when it comes to costs, a simple point needs to be made. Costs matter because returns are finite and are usually around CPI + 6%. If left unchecked, costs are infinite. 

“If we look at the industry, fees are very high and there is a misalignment when it comes to their allocation. Currently, about 79% of industry costs is allocated to investment management. Administration costs make up 15% while consulting with clients only makes up six percent. Surely it doesn’t take that many people to run a fund to validate the fact that investment management should make up 79%. In an ideal world, investment management should make up 20% of the industry’s costs, administration costs should be 70% and consulting with clients should make up 10%,” said Nathan. 

When considering Nathan’s ideal world scenario, costs are not being driven down, but are being shifted towards other areas. An increase in consultation costs may result in better advice which can drive up value. 

We are now tied (1-1) in the tussle between the existence of high costs vs the desire to drive them down. 

Nathan made a good point in closing his remarks. He said that the greatest predictor of future investment value is costs. If they are kept low, returns will be high. If costs are high, returns will be low. While this is common sense, it is a fact that is sometimes lost within the noise of the drive to manage costs. 

Thinking out loud

While there is no doubt that there needs to be a focus on cost management and a concerted drive to manage costs, Kirshni Totaram – Global Head of Institutional Business at Coronation Fund Managers – pointed out that if we focus on costs in isolation, we are completely missing the point of the debate. 

“If we focus on the role of costs without determining the value that is provided to retirees, we are playing a dangerous game. Different investment strategies carry different costs as do different risk profiles. If we focus on costs while ignoring value, then retirees may actually be left with less funds in retirement. Is this treating customers fairly?” said Totaram who challenged Nathan’s view of the finality of returns because a fund manager can either deliver suboptimal returns or can over perform when it comes to delivering returns. 

She added that if we are being honest, costs within the industry are being driven down, and the current trend of industry consolidation won’t hurt this. “There is safety in scale. Large companies are able to manage costs, and negotiate it better than smaller companies. Maybe the trend of industry consolidation is not the worst thing in the world,” said Totaram. 

A point to each party in the debate. 

Judgement call

At the end of the day, the client needs to be put at the heart of the investment decision when it comes to cost and they need to make the final call on what they are comfortable with. 

However, this is where the danger of direct investing and robo-advice detracts from value more than costs do. Retirees need to make this decision within the context of their investment. Advisers need to sit down with retirees and explain to them the existence of costs within the context of the value that they are receiving. This is why the recently released standard by the Association of Saving and Investment South Africa is so important. It is time to make informed decisions.

 Editor’s Thoughts:
Costs should never be sacrificed at the expense of value. This is a very dangerous game to play. Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts jonathan@fanews.co.za.

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