Regulatory shifts impact default investing strategies
The move from defined benefits (DB) to defined contributions (DC); the introduction of regulation 28 to the Pension Funds Act (PFA); and more than a decade’s worth of incremental retirement reforms have forever changed South Africa’s pre- and post- retirement funding landscapes.
Passing risk from employer to employee
“The move from DB to DC changed the landscape because the risk [in funding a pension] transfers from the employer to the employee; suddenly employees must think about asset allocation, investment risk and many other things they have not had to deal with before,” said Muitheri Wahome, founder of the Asset Management Research Institute (ARMI). She set the scene for a panel discussion on default strategies, held on day one of the 2024 Allan Gay Retirement Benefits Conference, themed ‘Through the Noise’.
Panel moderator, Radhesen Naidoo, Joint head: Institutional Clients at Allan Gray, had a broad swathe of topics to explore under the broad heading of essentials for suitable default investment strategies. In no particular order, he explored active vs passive; fee structures; local vs offshore; product types; and regulation. Bev Bouwer, independent investment consultant, has seen huge changes in the retirement funding space, spanning over three decades. “Advice on life stage defaults became more important with the introduction of DC funds,” she said, before applauding the effort and energy that consultants and trustees put into designing investment options.
To get default investment option design ‘spot on’ requires thinking about investments, manager appointments, portfolio construction and asset allocation, to name a few. “For fund members who happen to be in standalone retirement funds, trusting the default [usually pays off because] most of those default options are well managed, well considered and planned,” Bouwer said. Nowadays, both standalone and umbrella funds can create a wide variety of options for their members, with life-stage appropriate solutions being structured using regulation 28 compliant balanced funds among other investment products.
A balanced, market-linked option
“The product type world has evolved quite a lot; but at a high level, the balance fund option is really a market-linked option where you diversify between different asset classes,” said Sonja Saunderson, CIO at the Eskom Pension and Provident Fund. “Most funds in South Africa are following a multi-manager line-up of going into balanced funds [provided this is] appropriate for their strategy.” A balanced fund gives retirement fund members direct market exposure, locally and offshore; but it remains up to the fund managers to choose the optimal, risk-appropriate mix of asset classes.
Balanced funds are not protected from market volatility, meaning that investors’ capital is at risk. According to Saunderson, the industry initially responded to this volatility risk by investing conservatively; but over time a wide range of guaranteed and smooth bonus products emerged. Smooth bonus products involved an insurer ‘absorbing’ the volatility spikes that occurred from higher exposures to growth asset classes over time, providing more consistent returns to the investor, at a cost of course. “Guaranteed products typically have either a capital guarantee or some sort of a minimum floor level so that your capital is protected to some extent,” she said, conceding that these structures were complex with lots of embedded fees.
Keeping things simple
Naidoo interrogated the panel on how they balanced product types in standalone funds. Bouwer was first in the ‘hot seat’, saying that trick was to keep things simple and ensure that members could understand the default. It is also important to balance complexity and cost. “You have to think through all the options available, and put them together in a package that is well suited to the final target audience, your fund members,” she said. Consultants bring much-needed experience and innovation to the decision making; but it is ultimately up to the trustees to make the decision.
“The trustees understand who their membership is; the consultant’s role is to listen and give the right options,” Wahome said. “Together, as fiduciaries, you deliver something that will help the member retire comfortably at some point.” Delivering a sustainable retirement result is a common objective across the standalone and umbrella fund environment. “The considerations on a standalone and umbrella fund will be fairly similar; the key difference is that the umbrella fund caters to a wide number of companies, and should therefore have more options available,” she said.
The discussion then turned to new thinking in life-stage ‘switching’ in the pre-retirement funding space, especially given improving mortality rates. A decade ago, switching to a conservative portfolio 10-years pre-retirement was quite common; but nowadays, the focus is more aligned with savers’ evolving needs. Bouwer hinted that retirees were less obsessed over retirement dates, freeing them up to stay invested in more aggressive fund options for longer, both pre- and post-retirement. “The pension fund reforms, and the default regulations coming in, have placed an onus on trustees to make sure they consider better default annuitisation options for members,” Saunderson said.
Double-edged flexibility?
There are a couple of recent developments that have forced a rethink about pre- and post-retirement investing including changes to the regulation 28 offshore limits and the trend from active to passive investing. Naidoo asked the panel whether the flexibility introduced by these factors had the potential to cut both ways.
Bouwer commented that increased allocations to alternative asset classes came with higher costs attached. “You need to think carefully about balancing the most efficient solution for your members: that that add value at an attractive cost,” she said. This focus on reducing costs partly explains the shift into the passive world.
The active-passive and offshore-local concepts are somewhat intertwined in default investment strategy decision making. Saunderson contended that wide variances in asset allocation across strategies would result in wider variances in default outcomes. “The investment toolbox has expanded, introducing a lot of responsibility and options; but it also potentially introduces a lot of risk,” Saunderson said. Commenting on going offshore she noted two approaches: one being to capture the higher potential for global via ETFs and passive solutions, the other in partnership with fund managers.
The panel moderator asked why the South Africa retirement fund industry was slower than its global peers in transitioning towards passive investing. The consensus was that while the industry was slow off the mark, it was catching up. “Anecdotally, it is no longer active or passive and we are seeing a lot more hybrid default constructions; much of this is driven by the costs of investing in various asset classes,” Wahome said. There is, however, another way to explain the divergence in approaches.
A function of market size
According to Saunderson, it is easier to predict stock performance in South Africa versus large markets in Europe and the United States. “This is really as a function of the size of the market,” she said. “The smaller the universe, the more difficult it becomes for fund managers to add value through stock selection.” She added that while she remained an advocate for passive investing, the real clincher was making the right asset allocation. This explains the perhaps higher than trend role of balanced managers in the South Africans savings landscape.
To close this newsletter, your writer backs the following wisdom from Saunderson: The more efficient a market becomes, the more passive you should go because you cannot add much value from a stock selection effect.
Writer’s thoughts:
The hour-long panel discussion about default options in retirement left you writer with a sense of foreboding. Has the industry’s obsession with wider member choice done more to fuel complexity and costs that to improve retirement outcomes? Your thoughts? Please comment below, interact with us on X at @fanews_online or email us your thoughts [email protected].
