The value of smooth bonus portfolios
The economic uncertainty driven by increased market volatility exacerbates the difficulties investors face when making investment decisions.
For investors seeking protection from market volatility and their own emotionally charged decisions, they may be best placed to consider smooth bonus portfolios.
"The benefits of smooth bonus portfolios are often undervalued, misunderstood and even disregarded as they are seen to be too complicated. The unique features of smooth bonus solutions mean that investors across the risk spectrum can benefit from their value proposition," said Chris Cooke, Marketing Actuary, Momentum Corporate.
They provide exposure to growth assets, stable smoothed returns, reduced volatility, level of guarantee, and protection on the downside and have investment objectives that can deliver real returns over time.
To truly appreciate the value of a smooth bonus portfolio, financial advisers are encouraged to assist investors to understand its unique features and how they add value.
Below we have unpacked some of the key benefits of smooth bonus portfolios:
1. Exposure to growth assets
2. Smoothing of investment returns
4. Exposure to growth assets
Investors looking to reduce their risk exposure will tend to select more conservative solutions, with the resultant asset allocations shifting part of their growth asset allocation (i.e. largely equities and property) to bonds and cash. As a consequence the expected returns from such solutions are lower, potentially compromising an individual’s financial strategy.
The objective of a smooth bonus will target inflation-beating returns, and as a result the solutions will typically have allocations to growth assets ranging from 70 percent to 85 percent.
So not only are smooth bonus portfolios able to deliver real growth similar to market-linked balanced funds, they also provide the security attained in more conservative investments such as fixed interest and money market investments.
Maintaining such a higher allocation to growth assets ensures that an individual’s financial strategy is not compromised.
Smoothing offers investors protection from excessive market volatility. During periods of good market performance, some investment returns are held back in a reserve account before bonuses are allocated to investors. During periods of poor market performance, the investment returns held back in the reserve account can then be used to subsidise bonuses given to investors, ensuring a smoother investment experience and a less volatile investment journey.
The smoothing process is sometimes viewed negatively since investors in smooth bonus portfolios don’t immediately experience the full extent of a market increase. The value of the smoothing process can be seen when markets start to fall and the smoothing reserve is able to support bonuses in excessive of the returns earned in the market. For investors that cannot stomach market volatility, the smoothing process provides the necessary protection and ultimately, peace of mind.
Sometimes seen as the most complex feature of smooth bonus portfolios, guarantees protect investors against capital losses arising from benefit payments that occur when investment markets are depressed. The guarantees are applicable to certain insured events, referred to as benefit payment events in smooth bonus terms, and can include retirement, resignation, retrenchment, death and disability.
This sort of protection cannot be replicated in other market-linked funds, and should not be taken lightly. Guarantees can be either partial or full, and can be applied on the capital invested, declared bonuses or a combination of the two. Given the various guarantees available in the market, it is important that investors understand the guarantees and to ensure their strategy is aligned with their risk profile and needs.
Market value adjustments
Incorrectly viewed as an exit penalty, market adjustments are a key requirement in protecting remaining investors against potential anti-selection and to ensure fairness across all participating investors. Market value adjustments may be applicable on voluntary withdrawal, which typically includes members electing to switch to another investment option, or a retirement fund terminating the entire smooth bonus contract.
If a market value adjustment is applicable, an investor would receive a lower amount than his or her fund value to reflect the current market-related value of the contract. If investors were not subject to a market value adjustment, they would effectively be allowed to withdraw more than what their policy was worth. This withdrawal would negatively impact the bonus potential for the remaining policyholders.
Resignations and retirements are voluntary, but are considered benefit payments and an investor would receive his or her full guaranteed value in either instance. Therefore, resignations and retirements are not subject to a market value adjustment.
The impact of investment risk factors such as a market under-performance highlights the important role that financial advisers play in ensuring that investors stay on track with their investment goals despite unforeseen life events.
Cooke said, "Although not cost neutral, smooth bonus solutions provide investors with access to a smoother investment journey, maintaining their position to achieve their desired return objectives through material exposure to growth and at the same time protecting them against accessing their benefit payment when markets are depressed".
Smooth bonus solutions offer investors the best of both worlds: exposure to growth assets combined with downside protection and aim to address the common investment behaviour in South Africa whereby investors opt for more conservative investment options which may hinder their retirement goals.”
"Partnering with a game changing smooth bonus provider with a demonstrable performance history, offering capital guarantees at the lowest cost, will promote a holistic approach to financial planning that will ensure that investors have a smoother investment experience and are protected from market volatility while meeting their investment objectives," concluded Cooke.
Supplied by Momentum Corporate