October is retirement month and it serves as a good reminder to review your retirement plan. Will lower service fees provide a better outcome for fund members at retirement?
Retirement funds are important vehicles for building a nation’s savings pool as it allows for monthly contributions which grows over extended periods of time through the power of compound growth. The South African retirement fund industry has experienced some of its most challenging periods during the past few years. The Covid pandemic, lower interest rates and subdued market returns have resulted in inflation beating investment portfolio returns being hard to come by. Slow economic growth together with the impact of the pandemic and recent social unrest have put pressure on membership growth and the ability of members to preserve their retirement savings when changing employers or being laid off.
The introduction of further regulatory changes and compliance measures as part of National Treasury’s retirement reform added an additional layer of complexity to the challenge of ensuring that members retire with sufficient capital. The lingering threat of a policy on prescribed assets together with the more recently issued green paper containing proposal on the introduction of a National Social Security Fund adds further dynamics to the mix of uncertainty. How Boards of Trustees, Management Committees and financial service providers respond to these challenges will be critical for the future financial wellbeing of retirement fund members and the savings pool of South Africa.
The Perfect Storm
Ineffective government policies, structural deficiencies, strained labour relations, low business and consumer confidence, the Covid pandemic as well as low levels of fixed investment resulted in local economic growth of less than 1% per annum over the past 5 years. The pressure on household finances led to many retirement fund members opting not to preserve their retirement fund savings when moving between jobs with emigration adding to the outflow of industry assets. There were therefore no meaningful growth in the membership and assets of retirement funds in South Africa over the past few years. A stagnant retirement fund industry, low investment returns, increasingly demanding regulatory requirements and the need to maintain or grow their profits created the perfect storm for the local retirement fund industry from a fiduciary responsibility and financial service provider perspective. While the South African economy is expected to recover reasonably well in 2021, the South African Reserve Bank’s latest outlook for 2022 and 2023 looks less promising as the deep structural deficiencies and challenges in the local economy remain.
One Stop Solution
One of the few ways for service providers to achieve their business goals and financial objectives is to try and obtain a bigger slice of the stagnant retirement fund industry pie. This has resulted in the industry rapidly moving towards a more vertically integrated service model based on a one stop investment service offering. If structured correctly, the model of an implemented one stop offering approach should not be a concern as it can still be delivered with the necessary level of independence. It is, however, the way in which critical elements of the value chain is being devalued in the interest of gaining a competitive advantage that should have the alarm bells ringing. An increasing trend is one where retirement funds are being approached with the proposition of providing critical services such as investment administration and advisory services at low or no fees. As if these very important and value adding service elements are of a commodity based nature and does not require the necessary financial support to maintain and develop them.
There are, however, various risks related to a model based on cross subsidisation and a single minded focus by retirement funds and service providers on lower fees being paid for the critical services required by retirement funds. It fundamentally speaks to the ability or inability of Trustees or Management Committees to properly perform their fiduciary duties and responsibilities over the long term. Unsustainable business and funding models as well as non-transparent fee structures could result in retirement funds and their members being left severely exposed from a regulatory, economic, governance, cyber-security or investment market perspective over time.
If investment administration services are provided at no cost one would be concerned about the future ability of the service provider to not only maintain but also to enhance the necessary human capital, system functionality, service levels and security service elements a retirement fund requires. Retirement fund administrators deal with the valuable personal details of members which needs to be protected as per the recently introduced POPI Act. Cyber security risk has become one of the top ranking concerns for the industry as per the latest industry surveys amongst Trustees and employee benefit consultants. The only effective way to proactively manage this risk is to ensure that the necessary financial resources, insurance cover, human capital and technological resources are available in order for administrators to perform their function. If administration is viewed as an extra layer of cost rather than a safe house of sensitive member information a retirement fund can easily be exposed to the permanent loss of members’ capital.
Not charging for investment advice raise the same questions about the ability of the investment advisory service provider to attract the best experience and skills as well as best of breed advice tools and methodologies in order to maximise investment returns for members up to and during retirement. The retirement fund could possibly find a saving on the service fees of an investment advisor or asset consultant attractive in the short term. However, this would ignore the risk of a less effective life stage and pre or post default investment strategy being implemented by the fund. Due to a lack of the critical thinking required to manage the various risks the strategy could be found wanting during times of market stress. A dysfunctional and non performing investment strategy can easily override the annual fee savings on the investment advice element over time. The compounding effect of just a 0.5% per annum sacrifice in investment returns could make a material difference in the end result for members over a period of 20 to 30 years and into retirement.
The retirement fund industry still have much work to do in becoming more transparent in terms of the various service fees being charged and who the real beneficiaries are. The ASISA Retirement Savings Cost Disclosure Standard (RSC) that came into effect from 01 March 2019 should assist the participating employers of Umbrella Retirement Funds to get a better understanding of what their members are paying for when it comes to each service being provided. Cost components to be disclosed as per the RSC industry standard include investment management charges, advice charges, administration charges and all other charges such as regulatory, compliance and governance fees.
Belts and Braces
The King IV Code of governance principles as it relates to retirement funds speak to specific principles when it comes to the fiduciary duties of Boards of Trustees and Management Committees. This includes the responsibility to ensure that the Fund have access to the necessary skills and expertise to ensure that the objectives of the retirement fund and its members are met in a sustainable manner. This would include staying informed about regulatory changes, identifying potential operational and investment risks, responsible corporate citizenship, avoiding conflicts of interest, a well-designed investment strategy as well as ensuring operational efficiencies and effectiveness. The proper governance of retirement funds can never be traded off against a single minded focus on administration and advice costs or investment performance only.
The Weakest Link
The local retirement fund industry have various challenges to deal with. To address these challenges the value of each service element in the value chain needs to be recognised for the role it plays in delivering sustainable solutions for retirement funds and their members. Service provider fees should always be an important focus for the Board of Trustees or Management Committees of retirement funds to consider as part of their fiduciary duty towards all fund members. However, they should have a balanced approach when it comes to finding the most appropriate solution as the service provider value chain is only as strong as the weakest link. In a race to the bottom to find the cheapest fee option the members of a retirement fund might ultimately pay the price and only get what they paid for. A cyber risk event or a material oversight in the investment strategy of the fund could result in the permanent loss of capital or an opportunity loss in terms of investment returns for members.
Paying an appropriate fee for the critical service elements should be viewed as an “insurance premium” to protect a retirement fund against potential risks related to member’s personal information, weak governance or poor investment performance. A more suitable approach would be for retirement funds to focus less on the cost and more on ensuring that the best value is obtained for the service offerings being paid for. This will result in a more secure, sustainable and quality retirement savings solution and will ensure that the ultimate goal of a better outcome for retirement fund members and South Africa as a country is achieved.