Wi is Towers Watson Asset Manager Review

WHAT default investment strategy, or combination of strategies, would in your view be appropriate for a large Defined Contribution retirement fund? (A default strategy is one in which members will be invested by default, if they do not make investment choices for themselves.)

Danie van Zyl, head: guaranteed investments at SANLAM EMPLOYEE BENEFITS says Sanlam does not believe there is a one-sizefits-all solution, or one that would be appropriate for all retirement funds, given the significant diversity in risk tolerance and financial sophistication in membership groups.

“From our annual Sanlam Benchmark Survey, it appears that a lifestage solution is the most popular default investment strategy used by Defined Contribution Funds, used by 59% of respondents. A life-stage strategy allows a fund to tailor a strategy to prioritise long-term capital growth at younger ages, while aligning a member’s pre-retirement savings with a default annuity strategy as they approach retirement.

“Often members also want to have more stable and predictable returns during this period when they have built up their largest retirement nest egg – in these cases we definitely prefer a smoothed bonus solution instead of cash as the end-stage in a life-stage strategy,” says Van Zyl.

Sara Herbert, head of investment consulting at OLD MUTUAL CORPORATE CONSULTANTS says the appropriate default strategy will be determined by a number of factors:

The Fund’s required real investment return, which in turn will be determined by the level of net member contributions towards retirement and the replacement ratio that the Fund is targeting for a given period of membership; the members’ tolerance for risk – as measured by short term volatility;

Whether or not member investment choice is offered; The Fund’s annuity strategy; and, The profile of the membership – considering salary levels, average age or average age weighted by fund credits, educational levels, and nature of industry.

General characteristics of appropriate default strategies are that they target maximum returns within agreed risk constraints with a recommended time horizon of at least five years and that they take account of the expected post retirement investment requirements.

Nadia Van Der Merwe, business analyst, at ALLAN GRAY says a default strategy should obviously be one which is appropriate for most members. It should be simple to understand and provide members with (a) the opportunity to earn real long-term returns, which they will need if they are to retire comfortably, without (b) exposing them to undue levels of risk of capital loss.

She says the default investment strategy should account for the fund’s member profile and risk tolerance, as well as the default post-retirement strategy. A fund with a young member profile may find a strategy towards the higher end of the risk spectrum most suitable, as members have a longer investment horizon and should be able to tolerate short-term volatility. Conversely, a fund where the average member is closer to retirement may opt for a lower risk strategy, with a low probability of drawdown in the short term.

“Fund members’ tolerance for investment risk can also depend on the default post-retirement strategy. Where this is an investment linked living annuity, the argument for de-risking is less compelling, especially if retirees have a reasonable life expectancy. Members need to maintain reasonable exposure to equities and other growth assets to

generate higher real returns over the long term, to sustain their income. An appropriate pre- and post-retirement investment strategy may therefore end up looking very similar, with little or no de-risking necessary.

“However, if the majority of retirees are expected to buy guaranteed annuities, the argument for de-risking becomes stronger. There will be much lower tolerance for capital losses shortly prior to retirement as these losses may crystallise and result in a permanently lower level of guaranteed annuity income post retirement.

“No single default strategy is appropriate in all circumstances. The most suitable strategy depends on a number of factors specific to the fund and its member profile, which may also evolve over time,” says Van der Merwe.

Asief Mohamed chief investment officer at AEON INVESTMENT MANAGEMENT says the majority of members will generally select the default investment option as they perceive it to have the least risk and possibly the best blend of investment managers.

“Human Resource departments should have their investment administrators run continuous member education programmes across all staff levels over and above the annual wellness programme in well-defined, life-stage default, low cost investment strategies. A well-defined, life-stage, low cost default strategy would work well for most employees.”

Natalie Phillips, head of institutional at INVESTEC ASSET MANAGEMENT says she believes a multi-asset solution is the most effective strategy as a default for members.

“We would recommend a balanced strategy that includes offshore exposure and the flexibility to invest in alternative assets such as hedge funds, credit and investments in Africa beyond South Africa, to optimise risk-adjusted returns.

“A broad opportunity set provides potential to build a balanced portfolio across a range of growth, defensive and uncorrelated asset classes, to help members achieve returns significantly ahead of inflation over the long term, while limiting downside risk in the short to medium term.”

Charles Booth, chairman of investment committee and portfolio manager at TRUFFLE ASSET MANAGEMENT says a pension fund’s biggest risk is not maintaining members’ capital in real terms over the lifespan of the average membership and secondary to that risk is the responsibility of providing a sufficiently high return to provide the member with adequate retirement capital.

“Given these risks, and considering that the typical member is contributing for roughly forty years, a default investment strategy should have a strong growth focus that should include a significant exposure to equities (both local, international and private) and property. The current Regulation 28 provides for a maximum of 90% of fund assets in combination invested into these asset classes and I would regard that as sensible and desirable in the early years of a members’ life.

“As the member approaches retirement, it does make sense to scale back on the volatile, low yielding assets (equities) in favour of less volatile high yielding asset classes such as bonds. However, unless valuations are at extremes even over short periods of say five years, equities have a good track record of outperforming bonds so I would not scale back growth assets too much. I would say that (again assuming valuations are not at extremes) a 75:25 split between growth assets and fixed income would be sensible in the last say ten years of membership.

“Generally, I believe that the retirement industry has in the past had less than optimal exposure to growth assets and considering that inflation is most likely here to stay, the industry needs to favour growth assets more than it has in the past,” says Booth.

Neo Mokhesi and Litha Madabane, trainee investment analysts at ARGON ASSET MANAGEMENT say retirement funds usually have members from various age groups. No single investment strategy will therefore be appropriate for all members – the default strategy will have to be a compromise to meet different needs.

“Older members have a shortterm investment horizon and require more capital protection. Younger members have a long-term horizon with many years of earning potential; however, they require protection from inflation through assets that deliver inflation-beating (real) returns.

“As a result, the default strategy would have to be a compromise in the form of a moderate risk portfolio, for example an absolute return portfolio (CPI+4). Such a portfolio targets real returns but also provides protection against market downturns, since it aims to always deliver positive returns, irrespective of market volatility.”

Dr Adrian Saville, founder and CEO of CANNON ASSET MANAGERS says regarding a default investment strategy for a defined contribution fund, a useful point of departure is to understand the “characteristic” demographic makeup of the contributing group and assess other attributes that impact on risk profile and investment requirements.

“For instance, the default strategy for a group that is young with few dependants and high income earning potential would be different to the default strategy for a group that has a higher median age, fewer years to retirement on average and a lower income profile,” says Saville.

Paul Cluer, managing director at FOORD ASSET MANAGEMENT says the core portfolio should comprise a selection of the best fund managers, with excellent, demonstrable, long-term track records that evidence persistent top-ranking returns. Manager selection should favour the best, not the cheapest, fund managers and trustees should resist the urge to change managers regularly.

“The critical asset allocation decisions should be outsourced to professional fund managers with appropriate and long-term asset allocation track records.

“Passive strategies should be considered but used judiciously given the on-going requirement for asset allocation decisions.

“Investment strategies that employ guarantees have consistently underperformed astutely managed active portfolios and these should not form part of the default portfolio.

“The default strategy should be made available to members up to, and into, retirement - the fund should facilitate a seamless investment strategy in the pre-retirement and post-retirement-annuity phases.

“Life-stage portfolios that start reducing a member’s allocation to growth assets well before retirement are damaging to members’ long-term savings outcomes and should be avoided in default portfolios,” says Cluer.

Dr Fernando Durrell, head: multiasset at VUNANI FUND MANAGERS says given the varying times to retirement of contributors, necessitating various levels of equity exposure, the most appropriate default solution is a balanced fund, in particular, an inflation targeting fund, to increase the probability that members can maintain their purchasing power parity.

Batsile Ngomane, head of strategic initiatives at ASHBURTON INVESTMENTS says the company subscribes to an ‘outcome based’ approach when constructing investment solutions that satisfy investor needs effectively.

“Considering South Africa’s low net replacement ratios, members have little propensity to absorb risk and require meaningful investment returns from their retirement where returns are achieved at the least possible risk and at no more cost than is necessary –and delivered in a transparent manner.

“Members have diverse investment needs, so a single catch all default choice in our view would serve the needs of few while the needs of many fall by the wayside.

“We believe that the default options could be reduced to two choices, the first being a low growth portfolio offering high capital preservation for those members close to retirement (five to seven years); and the second portfolio being a high equity multi-asset portfolio serving members that have more than seven years to retirement.

“To achieve this, we offer an investment strategy that invests in diverse sources of return where returns can be achieved at the most efficient risk and costs. We believe that risk premia is accessed most effectively by investing in risk factors, and accessed across a combination of passive and active strategies.

“We therefore see the asset managers’ duty to be an on-going assessment of the merits of the various risk premia and stock selection, ensuring that investors are exposed to the relevant risk premia and in the right proportion appropriate for the investors need,” says Ngomane.