Retirement fund reform: do not ignore active management

This is according to Windall Bekker, Partner at REZCO Asset Management, who says a blended active plus passive approach to investing can bring significant benefits to retirement fund members.

 

"In its efforts to try and tackle the issue of retirement funding reform, which aims to ensure that fund members have a better chance of retiring comfortably, the National Treasury has encouraged trustees to consider index-tracking investment portfolios together with actively managed portfolios, because it believes that this will help to bring down costs and reduce risk.”

 

Bekker says the rationale for the suggested use of index tracking funds includes the fact that such funds generally have significantly lower management fees than active managers. Also, most index tracking funds do not have performance fees, since they aim to replicate the market performance either on the overall level such as JSE FTSE Top 40, or industry specific products such as RESI (resources), INDI (Industrial), FINI (Financial).

 

"Although there are always active managers that outperform passive investment products, it’s very difficult for the same manager to consistently outperform the comparable passive investment product. It is also very difficult for investors to identify what manager will outperform the market before they actually outperform.

 

"On a post-management and performance fee basis, the alpha or outperformance of the active manager is often significantly reduced, especially where performance fee are significant without any caps on performance. Performance fees are sometimes also very complex to calculate, making it difficult for investors to measure the active manager’s actual outperformance on a post-fee basis. To quote Warren Buffet, ‘The gross performance may be reasonably decent, but the fees will eat up a significant percentage of the returns’.”

 

Nonetheless, says Bekker, active managers do play an important part in the market, as they offer products that complement passive or index funds in very positive way. He says that a blended active plus passive approach to investing can bring protection against downside risk and potentially higher returns during strong equity markets.

 

"For example, a passive beta core complemented with an active satellite manager can provide investors with a fund that protects against downside or loss, while at the same time participating in the upside when markets rise. If the fund is constructed correctly, this means that investors can have better protection against losses in bear markets while outperforming the overall market in bull markets.

 

"The difficult part is identifying those active funds that offer downside protection and upside participation, while at the same combining these active funds with the passive managers to give optimal portfolio structures to the investors.”

 

Bekker says that in the retirement fund space, fund members must try to replace their income while they are working to the highest degree possible once they retire. This is generally referred to as the ‘replacement ratio’.

 

"Essentially, the replacement ratio is a comparison between your pre- and post-retirement monthly income. The higher it is, the closer you have come to having a similar amount of money to live on after you retire as you did when you were working. In order to reach this desired state, investors should ask themselves two questions when making investment decisions: ‘What is my current situation and my time frame? and ‘What is my investment objective?’”

 

He clarifies, "Investors with longer investment horizons, in other words, the amount of time that is left before the retirement age is reached and the funds need to be accessed to replace their monthly salary, can generally take on more risk because they have more time to ride out short-term market volatility. On the other hand, investors close to retirement can take on less risk, as they do not want to risk a significant drop in their investment value just before their retirement age is reached.

 

"In terms of the investment objective required to obtain the desired replacement ratio - in other words, how well the investment needs to perform over time in order to be able to retire with enough money – this is generally measured on an ‘inflation plus X%’ basis. Only when investors can answer these two questions above can they decide on an investment strategy and the underlying products and managers that can give the best probability of meeting their investment objective.”

 

Bekker offers the following suggestions:

 

• Ensure that manager’s business risk is diversified by investing with more than one manager, preferably with different strategies and styles.

 

• Try to ensure that your investment strategy provides you with downside protection and upside participation.

 

• Ensure that your strategy has the right mix of managers and products. Shorter time frames generally mean less risk, with more assets in cash and bonds, while longer time frames generally mean more aggressive assets such as equity.

 

• Try to ensure that your assets are not in cash, as cash returns generally are less than inflation and investors are guaranteed to be getting poorer. There are a number of excellent products in the market that offer similar liquidity while keeping pace with inflation.