Costs eating your retirement savings
Government is correctly concerned about the high costs of saving for retirement – some products provided by the financial services industry, particularly life assurance retirement annuities, have among the highest costs in the world.
Although the costs of occupational retirement funds sponsored by employers, industry sectors and trade unions tend to be lower, because of the economies of scale, these funds are not immune to the grasping clutches of avaricious service providers.
This column highlights some of the unacceptable practices to which National Treasury (and trustees of retirement funds) could turn their attention.
DOUBLE-DIPPING ON ASSET MANAGER FEES
There is a pervasive use of perfidious performance fees that, in the main, are charged on top of annual asset management fees.
An annual asset management fee based on a percentage of the assets under management is, in fact, a performance fee. The better an asset manager does, the greater the value of the assets under management, so (to quote one of my daughters) duh, the more the asset manager earns.
So why is it regarded as necessary to charge separate performance fees on top of this, particularly when the fees reward performance above carefully selected benchmarks but do not severely punish under-performance? The other problem with “performance fees” is that they reward market performance, as well as any skill that an asset manager may or may not add.
What makes performance fees even more unacceptable is that retirement fund trustees should not be seeking to shoot the lights out when it comes to performance but to provide returns that will meet long-term objectives.
For example, the trustees of a defined contribution retirement fund should tell you upfront that, based on your belonging to the fund for 40 years, they aim to pay you out a capital lump sum at retirement that should provide you with a pension equal to 75 percent of your final pensionable salary.
The trustees then need to take account of the contributions that you (and your employer) will make to your fund and calculate the investment returns required to achieve the targeted pension. The fund’s asset manager should be instructed to create a risk/return portfolio that, over the long term, will provide the desired outcome. It is definitely not necessary for the asset manager to be paid twice over for this.
HIGHLY COMPLEX INVESTMENT STRUCTURES
A number of important issues have emerged as a result of the placing under provisional curatorship of the Rockland Targeted Development Investment Fund (TDIF) in August.
TDIF is a private equity fund that, in the main, invested R518 million of retirement fund assets in barren sand dunes, which it claims are worth an astounding R848 million because of the potential to develop an urban centre and mine sand.
Although the issue is not related directly to the Rockland affair, it has come to light that some of the affected retirement funds have an enormous and complex variety of investment mandates. One of the affected funds is the Telkom Retirement Fund.
According to a Financial Services Board inspection report, the Telkom Retirement Fund claims it invested R60 million in TDIF on the recommendation of its asset management consultant, RisCura.
It has emerged that the Rockland investment is one of about 50 mandates held by the Telkom fund. I believe that one of the mandates was not even with a registered asset manager.
Keeping tabs on 10 – let alone 50 – different investment mandates would seem to me to be a trifle difficult even for the most astute retirement fund trustees and their asset management consultants. I would suggest that the Rockland affair confirms my contention.
Many of the Telkom Retirement Fund mandates were/are with asset managers that provide alternative investment strategies, in particular private equity (companies that are not listed on a stock exchange) and hedge funds.
I have yet to be convinced that there is a need for any retirement fund to invest in a hedge fund, particularly in a hedge fund that seeks to gain from short-term differences or swings in the market.
Among other things, hedge funds claim they can protect you from downswings in the market. In 2008, about half of the hedge funds in the world disappeared because they got it so wrong.
Then there is the crazy argument of the local hedge fund industry that these funds are aimed at institutional investors, such as retirement funds, and not at individuals. As one of my daughters would say: duh! Aren’t retirement funds the savings of many individuals, with the added admonition that they should be looked after with extreme care?
There are far stronger arguments in favour of investing in private equity. There are major and small companies with great potential, the shares of which are not available on stock markets.
The biggest problem with hedge funds and private equity is obtaining accurate valuations. If you want the job done properly, it is extremely difficult and expensive to value these investments.
It seems to me that all too often retirement funds are taking all the risks, while the managers of alternative investment products and various advisers are creaming off the profits. The managers of alternative investments charge far more than do the managers of traditional assets.
It is not only the costs of the product provider that have to be taken into account, but also those of a retirement fund’s service providers that assist with the investments, both their selection and after-care. And then there is the very real danger of greater losses if something goes wrong.
DOUBLE-DIPPING ON INVESTMENT OF ASSETS
In recent years, the retirement fund services industry has created a new job for itself (that is, a new way to make profits from retirement fund members). It is called transitioning.
An example is RisCura, which, in its promotional material, says it has the skills to ensure the transition of assets from one asset manager to another when a fund decides to switch asset managers.
RisCura claims the outgoing asset manager “is required to sell all the assets into cash by month end”. This is simply not true: the underlying assets can be retained and transferred to the new manager, unless, of course, they are assets in a private equity fund or, in some cases, a hedge fund.
Investments in private equity funds are, by their very nature, long term. The initial decision to invest should be made very carefully to avoid having to switch in mid-stream.
RisCura claims that every time a fund switches asset managers there is a fire sale that sees assets liquidated at “six to seven percent below market value”.
Medium to small retirement funds need, at best, only one or two asset managers to run the bulk of their portfolios; larger retirement funds may need a few more. These appointments should be long-term, well-considered decisions.
When there is a switch of assets between asset managers, retirement fund trustees should:
* Instruct the outgoing asset manager that, wherever possible, the actual underlying assets must be transferred to the incoming manager; and
* Ensure that the investment mandate given to the incoming manager includes the orderly restructuring of the investment portfolio.
The fund’s asset management consultant must play policeman to ensure that the trustees’ instructions are carried out – that is its job.
The transition management costs charged by companies such as RisCura are about 20 basis points (0.2 percent) of the value of the assets transferred.
It is an unacceptable conflict of interest where a retirement fund’s asset management consultant advises on asset switches and also plays the role of transition manager.
RisCura claims the transition manager is the only functionary that has an overall picture – well, I doubt anyone has “an overall picture” with a fund such as the Telkom Retirement Fund.
It would be interesting to know how many transitions that fund has made over the years. I can’t tell you, because the Telkom Retirement Fund is not answering my questions. Perhaps it is time the fund’s members asked their trustees a lot of questions.
Remember, the Telkom fund issued a statement to its members after news of the Rockland provisional curatorship broke implying that R60 million is a trivial amount of money. Perhaps it also regards transition fees as trivial.
COMMISSIONS, ADVICE FEES ARE HIGH RELATIVE TO PENSIONS
Since the publication three weeks ago of National Treasury’s discussion documents on saving for retirement and pension products, Personal Finance has received a number of letters from investors and financial advisers about the commissions and fees charged for advice on pensions bought with savings accumulated in a tax-incentivised retirement scheme, be it an occupational fund or a retirement annuity fund.
Obviously, the advisers think what they are paid is reasonable and well deserved, but those who do the paying think otherwise.
The big gripe is advice fees that are based on a percentage of the assets rather than the income generated – a no-lose method of charging for advice that could range from excellent to appalling.
The problem is that commissions and fees are paid almost by default. Take guaranteed pensions, where the life office pays three percent of the amount as a commission. The once-off three percent is supposed to be the regulated maximum, but it has become the default charge.
In the case of investment-linked living annuities (illas), the percentage is being pushed ever higher by devious little schemes designed to camouflage the default charge.
For example, there is practice called all-in pricing whereby – in co-operation with various unit trust management companies – a single amount is deducted for all costs at unit trust fund level.
Generally, illa advice fees seem to range from 0.5 percent to about one percent a year – and this can be a lot of money.
Let’s use retirement capital of R10 million as an example and see the effects. With guaranteed annuities, the commission of three percent equals R300 000, which is a huge amount considering the work actually involved.
With illas, the situation over the longer term is even worse. If we use 0.5 percent as an example, it means the adviser earns R50 000 a year. This may seem considerably less than the R300 000 paid on the guaranteed annuity, but, as one of our readers put it, the commission should be seen in relation to what the pensioner receives.
If the illa pensioner draws down an income at the minimum rate of 2.5 percent, he or she receives an annual pension of R250 000. In other words, the adviser earns a commission that is 20 percent of what the pensioner receives.
Remember that it is the pensioner who sweated, went without and saved over his or her working life to receive the pension. The question is whether an adviser is now doing work equal to one-fifth of what the pensioner did to earn that money? I doubt it.
We can safely assume that a financial adviser will earn fees from a number of pensioners. If we are conservative and assume that the adviser has 10 illa pensioner clients, it means the adviser earns R500 000 a year. These fees are paid year after year, so the fees paid on an illa will soon exceed the three percent on the guaranteed annuity.
Although government is right to recommend that retirement fund trustees provide members with lower-cost annuity choices that exclude commissions and fees, it is also up to you, the fund member, to negotiate a rand-based advice fee, particularly on a large lump sum.
Most product providers and advisers avoid quoting fees in rands, because they know it is easier to get away with quoting percentages. Ask for the figures in rands and you will quickly realise how much you will pay, particularly in relation to what you will receive as an income.