Solving the retirement fund puzzle
Being a trustee of a pension fund is a lot like trying to solve a Rubik’s Cube. Each task confronts myriad possibilities and permutations that must be taken into account in order to be correctly completed.
For the Rubik’s Cube puzzle to be solved, the blocks need to be matched up so that each of the six sides contains only one colour. Similarly, in discharging one’s duties as a pension fund trustee, there are various aspects that need to be matched up to meet the requirements of the fund.
“If you think of a retirement fund as a cube of data, with each side of the cube representing an aspect of your fund,chances are it is probably not organised and is therefore difficult to manage unless you follow a few simple steps,” says Windall Bekker, Manager of Investment Consulting at OMAC Actuaries and Consultants (OMAC).
According to Bekker, there are five key steps that trustees need to consider when it comes to solving the retirement fund puzzle.
Step 1 - Where are we now?
The first is to understand where your fund is now. This includes analysing the fund and its members to get a clear picture of the member demographic, such as the age, gender, socio-economic grouping, geographical spread and replacement ratios of the membership base. Various risk factors also need to be taken into account, such as time to retirement, accumulated credits, other savings and salaries of the members.
It is also important to analyse what kind of investments the fund has. This can be done using both quantitative and qualitative analysis.
Quantitative analysis involves analysis of risk, return, correlations and efficiencies. “Basically, you want lots of return for as little risk as possible,” says Bekker. “You also want to make your fund as efficient as possible. To do this you need to understand what is driving the performance of your fund. Multi factor analysis can also be used – whereby you analyse your fund against a peer group or alternative providers.”
Qualitative analysis involves looking at factors such as the make-up, experience, strategy and reporting of your investment manager. “It is important to know what is going on behind the scenes at the fund manager, such as the personalities and team dynamics which could have a bearing on performance and stability.”
Step 2 - Where do we want to go?
The second step to solving the puzzle is understanding where you want the fund to go. To do this you need to define and quantify the obligations of the fund. To ensure you are serving each member’s needs, you can separate the membership base into categories or “risk buckets” and define and quantify the liability within each of these. The investment strategy should then be set to match these liabilities.
“For example, the 'risk bucket' of members under the age of 25, who require growth plus, would require a very different investment strategy to the 'risk bucket' of pensioners, who require capital protection and income,” says Bekker.
Step 3 - How do we get there?
According to Bekker, the key to solving the retirement fund puzzle is selecting the right asset allocation. According to empirical research conducted both locally and internationally, correct asset allocation accounts for 90% of fund returns.
Constraints based on the membership profile need to be taken into account as part of the asset allocation process. For example, if a constraint is capital protection, the mix of asset classes selected for your fund will need to reflect this.
Selecting the fund managers best equipped to implement your investment strategy is also crucial. If there are a number of constraints, liabilities and “buckets” of members, this may be a complex procedure. Each of the different “buckets” may require a different strategy and it is important to select a manager who can best implement each strategy.
Finally, you should create and analyse the model portfolio and back test it for extreme periods such as the market crash of 1987.
Step 4 – Continual evaluation
A retirement fund investment strategy requires continual evaluation and review in order to identify gaps and reduce them until you reach your ultimate goal.
Step 5 – Get professional help
“Like solving a Rubik’s Cube, sometimes the best way to solve the retirement fund puzzle is to get expert advice,” says Bekker. “Investment consultants are valuable in helping trustees to ensure their fund meets member obligations, monitoring and managing fund performance and risk, continuously evaluating the financial markets and providing continual feedback and updates.”
