A well-designed default investment strategy should strike an appropriate balance between risk and return. Shaheed Mohamed, head of Group Savings and Investments, examines the factors to consider when selecting a default investment and the regulatory changes that are influencing their design.
The shift from standalone retirement funds to umbrella funds continues to gain momentum. While there are many factors that need to be considered when selecting an umbrella fund, such as the provider’s administrative capabilities, fees, service and transparency, among others, choosing the most appropriate investment option if you are an employer or member of an employer-sponsored retirement fund can be a daunting and complex task. A well-designed, trustee-approved default option can remove this burden for members while helping employers provide members with a high probability of reaching their retirement goals.
Trustees of retirement funds are mandated by law to make available default investment options that members will automatically be enrolled in on joining a respective fund.
There are several factors that trustees need to bear in mind when designing a default; key among them is ensuring that the objective, asset allocation, fees and charges, and risk and return are appropriate for the different categories of members in a fund.
Striking the right balance
With a retirement fund consisting of many different individuals, how does a default investment strategy account for their different needs?
The default investment option needs to consider every member who belongs to the retirement fund, and the trustees often make available more than one default investment option. For members who are nearing retirement and do not want to take on too much risk prior to retirement, there are various mechanisms to de-risk.
The most common approach is called life-staging, where members are switched from a balanced or growth investment option to a more conservative investment option as they near retirement. De-risking is not always appropriate for all members because some may still require exposure to growth assets when they retire and need to draw a sustainable income from their annuity. Members, therefore, will have the option to opt out of the life-staging. Additionally, members cannot be locked into default investment portfolios.
Allan Gray offers two default options, where de-risking begins three years from retirement age: The Allan Gray default, which life stages at a member level from the Allan Gray Balanced Portfolio to the Allan Gray Stable Portfolio; and the multi-manager default, the Multi-Manager Moderate Portfolio, which de-risks into the Multi-Manager Cautious Portfolio.
When considering the design of a default investment strategy, Regulation 37 of the Pension Funds Act stipulates that trustees should take both active and passive investments into account. The Allan Gray default is actively managed. However, when selecting underlying fund managers for the multi-manager default option, the Investment team is agnostic to whether the manager is an active or passive fund manager. Each is given an opportunity to earn a place in the multi-manager portfolios.
Transparency in fees
A well-designed default should be reasonably priced and competitive, and all fees and charges need to be disclosed.
One of the biggest challenges for consultants, employers and members has been to compare the costs or fees across providers. Providers have different fee methodologies, some with a lot of complexity. Also, not all providers have applied the same standards with regard to disclosures of fees. There are some providers that bundle administration for both investments and risk benefits, which makes it even more difficult for decision-makers to compare. However, disclosure is starting to improve.
Over the past two years, there has been a steady increase in the number of participants in investment advisory and wealth management firm GraySwan’s independent Umbrella Fund Default Investments Survey. The survey was commissioned by Allan Gray and launched in 2021 to promote transparency in the industry and make it easier for decision-makers to compare default investment options across providers. It is updated on a quarterly basis and is available via the Allan Gray website.
A changing regulatory landscape
A recent piece of legislation that may impact the design of the default options is the “two-pot retirement system”. The two-pot retirement system proposes to separate contributions to a member’s retirement investment into two components: one that can be accessed prior to retirement (“savings component”) and another that will be preserved until retirement (“retirement component”), with the proposed implementation date currently set down for 1 March 2024.
The question has been raised about whether the default investment option should account for a member potentially withdrawing from their savings component. Our initial thinking is that the default investment option should remain the same for both components as members should only be accessing their savings components when an unexpected financial need arises.
If members are actively planning to withdraw from their savings component at a future date, then the member would be able to opt out of the default. However, given that the amendments to legislation have not been finalised, it remains to be seen what the full impact of the two-pot system will be on default options, if any.
Another regulatory change that is influencing the design of default investments is the relaxing of the offshore investment limit, which was increased to 45%. With a higher allocation available to invest offshore, there will be a greater dispersion of investment returns between South African fund managers.
Fortunately, Allan Gray is in a good position to take advantage of offshore opportunities through our offshore partner, Orbis, who has been managing offshore assets on behalf of local investors since 1990, and through the expertise of our own portfolio managers who have recently begun to manage a slice of the offshore portfolio.
A long-term track record is key
From a trustee perspective, of equal importance to choosing the right default option is finding the right investment manager.
Trustees should choose investment managers that have a proven long-term track record of delivering good outcomes for clients and ensure that the investment manager’s qualitative factors are sound so that there is a high probability of continuing to deliver good outcomes for members.
Additionally, the investment management fee needs to offer value for money. There is often a chase for the cheapest or lowest fees; however, cheap fees do not necessarily equal good performance or good outcomes. Value for money is more important.
It is also important to investigate whether the fund manager has a strong track record and the “recipe” to deliver returns through market cycles.
Take your time to understand whether the fund manager has a good investment team with the necessary experience and whether that team is set up for continuity through multiple generations. Ensure that their investment philosophy is consistently applied, regardless of the market cycle and look at whether the shareholder and business structure allow for independent investment decisions.