Cost-cutting plan to boost your retirement savings

National Treasury is determined to put a financially secure retirement within your reach by reducing the charges levied on your investments, including opting for cheaper passively managed funds over actively managed funds. Bruce Cameron reports on Treasur

Low-cost passive management of your retirement fund savings, in preference to often high- cost active asset management, has been given an implied stamp of approval by National Treasury in proposals it unveiled this week to cut retirement- funding costs and improve member benefits.

In the last of five discussion papers published over the past year aimed at reforming the private r e t i r e ment- f unding i ndustry, Treasury says its proposals on costs are intended to provide options for discussion.

Treasury says the charges levied by commercial retirement funds, such as retirement annuity funds and umbrella funds, are among the highest in the world, while standalone occupational funds offered by employers are comparatively lowcost – but even with these funds members can be exploited by financial services providers.

Treasury says costs in the R2.3- trillion retirement- savings industry can be brought down by, among other things, consolidating funds, making membership of funds compulsory for all employees, preserving retirement savings until retirement, and improving the regulation and management of funds.

Treasury also sets its sights on charges levied by the financial services sector, proposing solutions for consideration by the broader retirement-funding industry.

In dealing with the costs of asset management, Treasury is critical of the under- utilisation of passive management, the use of performance fees by active managers, and the opaque costs of smoothedbonus, capital-guaranteed products provided by life assurers.

Treasury says retirement fund investment consultants, like other intermediaries, have a bias towards recommending products and services which increase their income, such as favouring active management over passive management.

Consultants can earn higher fees if they can persuade retirement fund trustees to employ them to assess and monitor the skills of various active managers managing different portfolios of assets.

Other examples of where consultants and others can earn additional fees are investment mandates that incorporate performance fees or complex, highly structured investment products.

Treasury says the alternative to active management, and a way for retirement funds to cut costs, is to make greater use of passive asset management. This means putting your investments in products that track various investment market indices. For example, a passive portfolio could track the FTSE/JSE All Share Index or sections of a market, such as the financial sector.

Active investment managers seek to identify under-priced assets in the hope that their portfolios will out-perform their peers.

Treasury says passive management is much cheaper than active management because there is little judgment involved and little trading. In the long run, the saving on fees compounds and becomes substantial.

“By definition, the ‘ average’ investor, whether active or passive, can only perform in line with the market. Half of funds invested will underperform the market in any given year, and half will outperform. Together, they make up the market. After expenses, the ‘average’ investor must therefore underperform the market,” Treasury says.

It says the case for active management is built on the idea that outperforming managers consistently outperform and that past manager performance is a guide to future performance. In the absence of consistent historic outperformance, “the case for active management falls down”.

OVERLOOKED FACTORS

Treasury says two important issues are often overlooked when examining the historical fund returns of active managers. These are:

Performance table survivor bias: actively managed portfolios that underperform are less likely to survive than funds that outperform. Performance tables include only portfolios that are currently trading. This results in an exaggerated average performance of active managers in comparison to benchmark indices.

Risk: many funds may take on extra investment risk. The effect is significant enough to make a substantial difference when analysing historical returns.

Treasury warns that you should view with scepticism any analysis of historical manager outperformance that does not correct for these two factors.

Broadly speaking, despite a large number of studies over many years, statistically robust evidence in favour of the persistent outperformance of active managers is weak, after taking these factors into account, Treasury says.

It says modern financial markets see investment managers trading highly standardised securities with many other skilled financial professionals from all over the world.

“All have a direct financial interest in exploiting any mispricing between different securities, and the cost of trading is lower than it has ever been. Consistently outperforming in such a world is extraordinarily difficult, and getting more so.”

This has driven the increased recognition of the benefits of passive investment management – in both unit trusts and exchange traded funds internationally.

Treasury says that locally indextracking portfolios are making slow progress for a number of reasons, including:

There is limited availability to retail investors on many linkedinvestment services provider (lisp) administration platforms, particularly on the cheaper fund platforms.

Behavioural factors, most notably the triumph of hope over experience. Few investors, wholesale or retail, seem willing to recognise their apparent inability to pick managers or stocks successfully and accept index-related performance.

Moral-hazard problems caused