Wi is Towers Watson Asset Manager Review
RETIREMENT FUNDS must also put in place an “annuity strategy”, under which a trustee-chosen pension option is offered to retiring members. This may be a Living Annuity (whether provided by the Fund or by an insurer), but the Living Annuity must be restricted to four investment portfolios. What in your view would be the ideal “menu” of choices for a Living Annuity, limited to only four portfolios?
Sara Herbert, head of investment consulting at OLD MUTUAL CORPORATE CONSULTANTS says appropriate living annuity portfolios must target sufficient long-term growth (of around inflation plus 4-5%.) to address members’ longevity concerns and be cost effective.
“When selecting the appropriate portfolios, consideration must be taken of the pre-retirement investment approach – for example if the default pre-retirement strategy is a multi-managed approach, then at least one of the post retirement strategies should be a multi-managed approach.
“Since living annuities are long term investments, passive is a viable option, however the living annuity pensioner must have sufficient other income to allow them to accept the fluctuating pension that a passive approach could deliver due to market volatility. As the volatility of the portfolio can have a significant impact, particularly in the first few years after retirement, portfolios that offer some volatility management, without significantly reducing potential returns, will be valuable.
“We have also found that a smoothed bonus approach works well in allowing members to access the growth assets needed whilst managing short term volatility, however the costs need to be carefully explored and understood.
“It’s also important for the living annuity to cater for pensioners that might be at an advanced age or who are very ill, with a resultant short time horizon and a desire to protect their capital,” says Herbert.
Nadia Van Der Merwe, business analyst, at ALLAN GRAY says limited choice is particularly important for clients who are not well equipped to make informed decisions. While the regulations restrict the menu to a maximum of four portfolios, there is no requirement to have as many as four options. Given the requirement for the default to limit choice and provide simple and generally appropriate options, four portfolios may still present too much choice for some members.
“Retirees often underestimate the long-term nature of their post-retirement time horizon and may be inclined to opt for portfolios that are too conservative. Crucially, the extent to which retirees are able to sustain their retirement income will largely depend on the degree to which the selected portfolios generate long-term returns in excess of inflation.
“Therefore, similar to the pre-retirement approach, a living annuity should provide annuitants with adequate exposure to equities and other growth assets.
“In our view, a living annuity should be invested in a multi-asset class portfolio that typically has the majority invested in growth assets, which are required to generate real returns over the long term.
“The investment parameters should provide the investment manager with sufficient flexibility to adjust the asset allocation to take advantage of opportunities as they arise, while being cognisant of and able to manage the risk of capital loss,” says Van Der Merwe.
Dr Adrian Saville, founder and CEO of CANNON ASSET MANAGERS says risk budgeting is one way in which to build the four portfolios, longer-term investment targets is another suitable avenue, as is certainty around yield generation.
Using strategy silos or even thematic profiles are other ways in which the four portfolios could be built.
Perhaps one of the most effective options, though, is liability profiling, as this is ultimately what the retirement fund is designed to match and exceed.
Natalie Phillips, head of institutional at INVESTEC ASSET MANAGEMENT says the suitability
of default investment portfolios is likely to be largely driven by the demographic of the fund membership and could therefore vary from employer to employer.
“Broadly speaking however, the idea behind a default is that the options provided should be suitable for the vast majority of members as this will be key to delivering better outcomes in retirement. Esoteric/ building block investment options are unlikely to receive much support and could even drive up the costs for a fund, which is contrary to the intentions of National Treasury.
“Studies have shown that retirees need exposure to growth assets in their living annuities to ensure their income is not only sustainable but also able to keep pace with inflation.
“We therefore suggest that for an employer looking to provide four investment portfolios, those default investment options should consist of multi-asset portfolios that also have offshore asset exposure covering the major risk categories of aggressive, balanced, moderate and cautious.
“There has been some comment suggesting that perhaps four portfolios is too restrictive, as it doesn’t allow for a Sharia-compliant option or for those who want to hold cash. In our view, however, these are too narrow for a default option.
“This does however highlight the need to use an administrator who can make these alternative options available for the few members who opt out of the default option,” says Phillips.
Danie van Zyl, head: guaranteed investments at SANLAM EMPLOYEE BENEFITS says before deciding on which four portfolios to use, one should first consider what strategy should be used as the default trustee-approved strategy.
“Members in a living annuity are particularly vulnerable, as they are carrying all the investment and longevity risk. Of particular concern is a big market crash soon after retirement when a member has his biggest account value.
“In order to get the same monthly income, members invested in a Living Annuity are selling more units from their investment than they realise. In many cases, this is the main reason why living annuity investment strategies fail.
“I once had a pensioner from the Free State phone me after I appeared on a radio interview, asking for help. He was 69 years old and had already halved his retirement capital and now had too little to see him through for the rest of his life. There is sadly no magic solution to solve a problem like this.
“To protect against this risk, we find that some members are overly conservative in their investment strategy – leading to inadequate retirement income when they reach their 80’s.
“At Sanlam we have modelled nearly all the investment portfolios in the market and found that not one adequately addresses the twin risks of a market crash after retirement and long-term low returns.
“Our strategy is to combine different portfolios for different stages of a living annuitant’s retirement journey – with one providing stable income and protection against a market crash in the years immediately after retirement while another prioritises high long-term capital growth. How one combines these portfolios is sensitive to a members’ drawdown rate.
“Once the default strategy is in place, a fund can add additional portfolios to allow a member to either take more or less investment risk. We have experienced significantly more engagements with funds about post-retirement investment strategies during 2017.
“An exciting development is that some funds are thinking of combining living annuity and guaranteed annuities in a post-retirement strategy,” says Van Zyl.
Neo Mokhesi and Litha Madabane, trainee investment analysts at ARGON ASSET MANAGEMENT say a living annuity is similar to a unit trust in the sense that the retiree bears the investment risk (the risk of the underlying assets not delivering the required returns) and the consequent risk that they will outlive their savings.
“An ideal ‘menu’ would therefore include portfolios across the risk-return spectrum, such as cash, core-high-yielding bond funds, conservative absolute return funds, and finally high-equity balanced funds.
“However, the allocation across these four funds will depend on the drawdown rate (the income withdrawn by the retiree as a percentage of the value of the living annuity – between 2.5% and 17.5% according to current legislation).
“The lower the drawdown rate, the higher the risk that the living annuity fund can tolerate. Overall, we are comfortable that four choices are sufficient to cover the risk-return spectrum for living annuities.”
Dr Fernando Durrell, head: multi-asset at VUNANI FUND MANAGERS says the annuity strategy is perhaps the most interesting aspect of the reform as it requires trustees to plan retirement horizons that extend beyond some retirement age of their members.
“Whether members are expected to live on average a further ten or twenty or thirty years beyond retirement will be material to the choice of annuity product (a guaranteed life annuity versus a living annuity, for example). Where a fund offers the option of a living annuity built on four portfolios, we believe that ‘menu’ should consist of a component capable of giving the annuitant a greater chance of capital growth, and a component focused on delivering current income equal to at least half the rate of inflation.
“Our underlying portfolios for such a strategy would consist of a full 25 percent allocation to global assets, a high dividend income local equity component, an inflation-protected component, and a nominal local bond component.”
Paul Cluer, managing director at FOORD ASSET MANAGEMENT says the regulation requires that the four portfolios offered in terms of the fund’s default living annuity strategy be Regulation 28 compliant.
“In our view, the best long-term savings outcomes result from investors maintaining their pre-retirement savings investment strategies into and through-out the post retirement phase, which with current longevity trends could last decades.
“Therefore, the fund’s annuity strategy should conform very closely to the default investment strategy for pre-retirement members, notably a selection of well-managed multi-asset class portfolios.
“Such portfolios offer a high probability of achieving real returns of 5% per annum and accordingly annuitants wishing to sustain the purchasing power of their retirement portfolios should prudently constrain their annual drawdowns to 5% or less of their retirement capital.
Batsile Ngomane, head of strategic initiatives at ASHBURTON INVESTMENTS says because the new retirement default regulations require that all pension funds offer default annuities to assist members with their choice and a required portfolio to sustain income, the company believes that annuity strategies should be informed by the members’ need considering other sources of income the member is receiving, the degree of investment certainty required as well as other requirements (such as dependents and surviving spouses).
“We think that the underlying portfolios of default annuities (living annuities) should be constructed within the parameters of these categories;
Portfolio of Inflation Linked Bonds (least risk portfolio);
Flexible Fixed Income Portfolio investing across a variety of fixed income instruments including, inflation linked bonds, nominal bonds and quality credit;
Diversified growth portfolio investing across a diverse range of investments (i.e., active passive, fixed income, alternate and real assets) with a reasonable level of capital preservation.
“We also think that the age and mortality risk of members need to be carefully considered when setting annuity rates within the default portfolios. For ease of transitioning from a pension fund into a default annuity, the same portfolios should be made available within the relevant annuity as far as practically possible.
“Members should, however, be allowed to go outside these parameters but should be made aware of the related risks, such as depleting capital and ultimately reducing their income,” says Ngomane.
Charles Booth, chairman of investment committee and portfolio manager at TRUFFLE ASSET MANAGEMENT says the ideal menu should include: an equity portfolio(including both local and international equities); a balanced portfolio that should include, in addition to a high exposure to equities, property and fixed income assets; a similar balanced portfolio but with a much lower exposure to equities; and finally a well-diversified portfolio that might include many non-vanilla products such as private equity, hedge and credit funds and other high yield products, much along the lines of many endowment funds.