Spoilt for choice

Variety of in­vest­ment choices comes with po­ten­tial pit­falls

Finweek English Edition - - Focus on employee benefits -

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

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