Spoilt for choice
Variety of investment choices comes with potential pitfalls
THE INCREASING NUMBER OF investment choices when choosing an appropriate retirement fund has not only left retirement fund members daunted but has also increased the responsibility on trustees to ensure that members are adequately informed in order to allow them to make the appropriate investment decisions.
Colin Bullen, head of specialised consulting at Lekana Employee Benefit Solutions, says trustees need to ask a number of questions to ensure that members are sufficiently enlightened about the various investment choices at their disposal: • Are you empowering the member to make an informed decision? Are you making enough information available to members? • Do members understand the information you’re making available? Does the available information suit the needs of a particular member? Are members utilising the resources at their disposal in order to make informed investment decisions? “Trustees need to evaluate whether or not they’re really raising the levels of awareness and understanding among their members, and they need to do this on a whole range of issues,” says Bullen.
James Louw, head of implemented consulting at Acsis, says the reason trustees should take investor choice seriously is because if members are able to demonstrate that they didn’t receive sufficient training, the trustees may be held accountable by those members.
“Trustees of member choice funds can run the risk of not meeting their investment fiduciary obligations and with the increased focus on legal vigilance they therefore run the risk of litigation,” he says.
Bullen agrees and says the potential for litigation does exist.
“We’ve been in a bull market for a number of years now, so not too many people have been concerned about the performance of their retirement funds,” he says. “However, at some point the market is going to turn, there are going to be incorrect investment decisions and people are going to end up with less money than they thought they were going to get. And it’s inevitable under the current situation that at some point the issue is going to be taken up with the board of trustees.
“In fact, one could argue that that case needs to happen in order to set a precedent, which could result in a turning point in the manner in which trustees are appointed.”
Louw says one of the problems of member investment choice is that members often end up making asset allocation decisions that are best left to investment experts.
The obvious danger here is a member mistiming the market when making an asset allocation in order to latch on to a recent trend. An illustrative example would have been members switching into technology heavy funds during the dot.com boom only to see it crash sending the value of their investments plummeting.
Louw says that the fact that members are allowed to change their investment choices throughout the year can lead to serious problems as members try to change their choices in an attempt to time investment markets.
“More often than not, this leads to a loss of capital rather than a gain. Making inappropriate investment decisions at the wrong time is often the main reason for members not being able to achieve their investment goals.”
The other obligation on trustees is to ensure that portfolio choices are aligned to a member’s specific needs.
For example, it could potentially be inappropriate for a member with one year to go until retirement to invest entirely in equityheavy portfolios.
By the same token, it would not be suitable for a young person in his twenties to opt for a portfolio that’s heavy in cash and bonds.
However, this in itself raises the issue of age or life-stage banding, which Louw says should be adopted with extreme caution.
In essence, the age-based approach determines a risk profile for a fund or its members by analysing the individual member’s time to retirement. The risk profile then determines the asset allocation, which in turn provides a return on investment that ultimately determines what a member will receive on retirement. The focus is therefore on the risk profile input and not on whether the amount will actually be enough to sustain the member throughout retirement.
For example, a member aged between 30 and 40 years will receive an aggressive risk
Trustees need to evaluate whether or not they’re really raising the levels of understanding among their members.
profile resulting in a greater proportion of equities to bonds in his portfolio, whereas a member aged between 50 and 60 years will receive a conservative risk profile, requiring a greater proportion of bonds to equities.
Louw says the biggest risk of age-based strategies is that they do not take into account members’ individual needs. Members who make decisions based on age or market movements run the risk of incurring insufficient growth on their investments to meet their retirement needs. Members also don’t understand the consequences or implications that an investment may have on their retirement needs and therefore are not being empowered to make an informed investment decision.
Says Louw: “Rather than basing his investment choice on age, the option should be considered in line with a member’s total financial position and in relation to the member’s needs on retirement date.”
Life-stage banding should be adopted with extreme caution. James Louw