Group savings should be an extremely efficient way to prepare for a comfortable retirement. Nazia Suleman and Saleem Sonday discuss how Allan Gray plans to make a difference in the retirement savings space.
The Australian Centre for Financial Studies has an index comparing pension systems across the world – the Melbourne Mercer Global Pension Index. While they acknowledge that comparing systems is controversial, as each country’s system evolves from unique circumstances, there are certain characteristics that can be applied universally. The index rates each country based on the system’s adequacy, sustainability and integrity.
Sadly, South Africa comes in well below average overall, with the key pressure point being adequacy, which considers the benefits provided to both low and middle-income earners, as well as general characteristics which describe the efficiency of the overall retirement income system. We can learn from countries that do well, such as Denmark, the Netherlands and Australia. These are all countries which have inclusive systems that benefit from scale efficiency, while still delivering high-quality investment management.
The South African retirement industry today (excluding the government pension fund) manages assets of around R1.8 trillion. Of this, around 49% is in non-commercial funds, 17% in commercial umbrella funds and around 34% in individual retirement annuity accounts and preservation funds. Over the last four years, the market share of commercial umbrella funds has increased by two thirds (from a base of 10% in 2012), at the expense of stand-alone employer funds. This should be a good thing. Since an umbrella fund clubs together thousands of employees from different organisations in a single fund with standardised rules and a single board of trustees, it is more efficient to govern and administer than a stand-alone employer fund.
Like all employer-sponsored funds, umbrella funds are also typically better than individual retail arrangements. With employer- sponsored retirement saving, employees save for retirement as part of their conditions of employment (which should mean lower distribution costs for providers and thus lower fees) and employers represent a big enough group of employees to negotiate better fees than each employee could on their own. These advantages should result in better outcomes for members than small and mid-sized employer-sponsored funds can offer but this isn’t always the case.
The commercial umbrella fund market is dominated by large life insurance companies which together make up 85% of the market. Although there are some funds that offer super-efficient administration and simple products that sell themselves, mostly, umbrella funds today have a reputation for high costs, poor transparency and ill-disciplined (or maybe worse, contrived) complexity. Search the term ‘umbrella fund’ on the HelloPeter service feedback website for a frank review of the state of customer service: it isn’t good. If you’re a business owner or finance director, request quotes from three providers and try to compare costs. You won’t be able to, or at least not easily. There are some services where it is inherently complicated to compare costs – for example health insurance, where the benefits can vary significantly between different plans. Retirement savings should not be complicated at all: the service offered is very standardised and price and value-for-money should be easy to compare. Fees for administering retirement savings are often bundled with those for group life and disability insurance cover. The target is offered invoicing convenience in return for opaque pricing.
We think this is an industry that could do with more competition. A new entrant using technology to provide better service than the incumbents at a competitive and more transparent price could win over some clients. If they already had a trusted brand (for example, Allan Gray), and the first clients were impressed enough to tell others, the newcomer could build scale without having to pay commission to a large sales force and recover this from their clients.
Umbrella fund members need high quality investment management, value for money and great service
Investment returns have a large impact on retirement fund members’ capital over time. The best investment teams in South Africa are independent: they aren’t allocated assets preferentially from an in-house balance sheet and they don’t have sales armies pushing their funds in an in-house distribution force. Without these advantages, independent managers are heavily dependent on their performance in order to run sustainable businesses: the survivors are better because of natural selection. A good umbrella fund should offer members unbiased access to the most highly-regarded SA investment managers. Choice is good, but too much choice is not always a good thing.
Fees disclosure is critical to ensure that where a member or employer representative is exercising choice, they understand what they will be charged for and how much, and are equipped to make the right decisions. While retail investment products like unit trusts have well-defined disclosure standards which aim to facilitate value-for-money comparisons, in the group retirement savings space, cost comparisons are more difficult. The way fees are disclosed varies from one provider to the next making decision-making challenging and often leading to poor outcomes for members. A better understanding of the types of fees that are charged can help you to assess your options if you are an employer looking for a group retirement saving solution, and provide some clarity if you are a member trying to understand what you are being charged.
There are four common types of fees that apply in retirement funds, but it is important to look at the total fee over a period of time when comparing different providers to ensure a proper understanding. This is because providers often discount easily comparable fees, for example administration, and make up their lost revenue where it is less easy to compare, for example with fees on risk or investment products.
1. An administration/product fee
This fee is charged to administer the member’s monthly contribution and to direct it into the selected portfolio(s). This fee is typically highly correlated to the range of investment options available within the product. A lower fee may mean there is a limited range of investment choices, while a wider range often results in higher administration fees. There is no industry standard as to how this fee is levied, which makes it difficult to compare administration fees across providers. It is usually expressed as one of the following:
- A percentage of a member’s salary
- A percentage of a member’s assets in the retirement fund
- A rand-based fee per member per month
2. An investment management fee
A percentage fee is charged for investing the member’s contributions in each portfolio selected. The investment management fee is intended to compensate the managers for their time and expertise for selecting stocks and managing each fund within the investment portfolio. Investment management fees typically vary depending on the underlying investment manager selected. In addition, this fee is often linked to the administration option selected (as mentioned previously). Traditional umbrella fund service providers typically price administration very cheaply provided that their in-house default investment portfolio is selected. This leaves them with less incentive to price the default portfolio attractively.
3. An adviser/consultant fee (only if an adviser is appointed)
This fee has to be agreed to between the employer and adviser. It can be charged either as a percentage of contributions, or as a percentage of assets, or a combination of both.
4. A fee for risk benefits
This fee is charged to access risk benefits, such as life cover, disability and/or income protection benefits.
Fees which charge a low percentage of salary for administration and make this up with a higher ongoing investment management fee charged as a percentage of assets are often cheaper for a year or two and then become more expensive for members over time, as their asset balances increase. This is because, for the average member, salaries increase at close to inflation and yet investments should grow at a few percentage points more than inflation. When charges can be deducted either as a percent of salary or as a percent of assets, it matters which of these will grow at a faster rate. To compare the two, employers would be well-advised to consider fees over many years into the future to make sure they are getting the best deal.
It is probably clear to you by now that we are excited about launching a new umbrella fund, which allows employers to give their employees access to the best investment managers in South Africa at competitive, institutional prices. Through the Allan Gray Umbrella Retirement Fund we aim to offer a product that makes things simple for employers and puts member needs at the centre by offering an unbiased, limited range of high quality managers, fair and transparent pricing and great service. If we get this right, there is an opportunity for us to contribute towards improving the South African retirement saving system.
Our Umbrella Retirement Fund has a simple product and fee structure, which means that employers and their employees have clear sight of contributions, returns and charges. The Fund offers no built-in risk benefits: retirement fund contributions are only used for their intended purpose, i.e. saving for retirement. We can put employers in touch with an independent specialist risk benefits provider to arrange group risk cover for their staff. Members benefit from competitive administration and investment management fees and there are no hidden costs.
Everyone gets the same excellent service regardless of their contribution levels. Members can contact our Client Service Centre during business hours if they have any questions and they can monitor and manage their investments through their own secure online account. We also invite all members to learn more about the importance of saving for their retirement via our website and we are happy to provide customised training and member education on request at no additional charge.