Almost 60 percent of stand-alone, employer-sponsored retirement funds offer investment choice to members, but 83 percent of members choose the default option provided by fund trustees – an option that may not be suitable close to retirement.
A key finding in the Sanlam Benchmark Survey of retirement funds is that members say they are confident that their fund trustees will make appropriate choices for them, but there is a risk that the trustees will get things wrong.
And now trustees face the prospect of assuming a greater role in the post-retirement outcomes of their members, as their duties are likely to include choosing default annuities (pensions) for members who do not want to make their own decisions. A recommendation for trustees to take on this role is contained in government’s retirement reform proposals.
The Sanlam survey reflected that 20.4 percent of current pensioners would have preferred their fund trustees to provide them with a default pension option at retirement rather than decide on their pensions themselves.
Against this, 90 percent of employers surveyed have no interest in the post-retirement welfare of the members of the funds they sponsor.
Rhoderic Nel, the chief executive of investments at Sanlam Employee Benefits, says that member apathy towards retirement fund investment decisions is placing considerable responsibility on fund trustees to ensure that appropriate default options are in place.
The Sanlam survey also shows that 72 percent of members make retirement fund choices on the first day of their employment and then never revisit that decision.
Danie van Zyl, the head of guaranteed investments at Sanlam Employee Benefits, warns that choosing an investment portfolio and converting retirement savings to a pension at retirement can “be a daunting task, even for financially astute investors”. He says many fund members find the array of choice intimidating, with too much choice leading to “decision avoidance”.
Nel says it’s difficult and risky for trustees to select default portfolios, as they need to:
* Ensure the portfolios provide suitable, sound long-term returns, while ensuring members are not exposed to high levels of risk; and
* Select a portfolio that meets a spectrum of members’ needs, which vary over their lifetimes and over different investment horizons.
More than 60 percent of trustee boards choose what are known as “lifestage” portfolios. These are structured so that in the early stages of saving there is higher exposure to higher-risk investments intended to deliver capital growth. Later, as a member approaches retirement, the portfolio reduces the exposure to these higher-risk assets to protect the member’s capital.
The survey reveals that 54 percent of funds using a lifestage strategy convert all of their members’ savings to cash in the final year before retirement.
This can create what is called the “lifestage gap”, Van Zyl says. He says the years immediately before retirement are when members’ fund values are at their highest, and it is “crucial that members aim to earn a decent return in excess of inflation over these years. This is unlikely when invested in cash.”
Nel says the risk of a lifestage portfolio means that members may be “giving up a significant amount of growth on their investment for this protection.”
But exposure to more volatile higher-risk assets, such as equities, “means that members run the very real risk of a sudden drop in the value of their investments before and at retirement”.
The survey reveals that only five percent of funds use smoothed-bonus portfolios as an option close to retirement to ensure members have sufficient exposure to growth assets while benefiting from capital protection, Nel says.
Smoothed-bonus portfolios are provided by life assurance companies. They guarantee part or all of the capital and certain investment growth. Some investment growth in years when market returns are good is held back to ensure better growth in years when returns are poor.
Van Zyl says a smoothed-bonus portfolio, such as the Sanlam Stable Bonus portfolio, which provided a five-year return to the end of 2014 of 13.33 percent a year with little volatility risk, would be a better option than cash.
The survey also revealed that most trustees make decisions about investment providers themselves, and only 26 percent of funds select investment providers based on the advice of an investment consultant.
Van Zyl says a mismatch between a member’s pre- and post-retirement vehicles can result in the member’s savings being disinvested from capital growth assets just before retirement and then being used to buy growth assets again at retirement, if the member chooses a with-profit or living annuity.
Nel says that fund trustees should reconsider the default options for members close to retirement to ensure that they match their post-retirement income choices. This would involve getting advice from an investment consultant.
Nel says the Sanlam survey has revealed that 54 percent of funds offering lifestage investment default options are now trying to match the final stage of investment portfolios with the type of annuity that will be purchased.
For example, a smoothed-bonus portfolio would be a suitable investment prior to buying a with-profit annuity, as the products have similar smoothing philosophies.
A moderate-risk (medium equity) balanced portfolio, investing across all the asset classes, would be appropriate for a member wanting to buy an investment-linked living annuity, in which the appropriate underlying investment would also be a balanced fund, Nel says.