Fatima Vawda, MD of 27four. Picture: FREDDY MAVUNDA
Fatima Vawda, MD of 27four. Picture: FREDDY MAVUNDA

Two new players have entered the smoothed bonus retirement fund market, showing there is still a strong demand for this strategy.

As a retirement saver, you can take on higher investment risk with its higher volatility and be rewarded with higher returns because the long time horizon for which you are investing makes it possible to recover from downturns in equity markets.

But some retirement fund members are not comfortable with negative returns even if they still have many years before retirement. The trustees of funds serving these members - typically union fund members - often opt for smoothed bonus funds.

Traditionally, these have been offered by the larger life companies, Old Mutual, Momentum, Sanlam and Liberty. They combine smoothed returns with guarantees on the capital invested in an attempt to ensure members' returns are always positive.

Late last year multimanager 27four partnered with Sanlam Employee Benefits to launch the Progressive Smooth Bonus Fund, the first such fund which is multimanaged and entirely managed by black investment managers. Sanlam provides the guarantee on 80% of the capital invested.

Fatima Vawda, MD of 27four, says the fund is invested across the asset classes with up to 60% in equities and it targets a return of four percentage points more than inflation (inflation plus four) after all fees.

This month investment manager Sygnia also launched a new smoothed bonus offering - the Stabilised Growth Fund.

Its unique feature is that it does not offer a guarantee as Sygnia believes these are expensive and seldom necessary.

Fund trustees can choose between Sygnia's index-tracking Skeleton 60 fund or the Signature 60 fund, which uses both index-tracking and active management. Both funds are multiasset or balanced funds with a 60% equity allocation that Sygnia's fund managers can vary over the short term.

David Hufton, Sygnia's head of special projects, says many smoothed bonus funds are more conservatively invested than Sygnia's fund despite the fact that they have guarantees against investment losses that cost members additional fees.

Sygnia's smoothed bonus fund targets a return of inflation plus 5% after costs over rolling three-year periods.

Hufton says the cost of the smoothing is around 0.15% a year but the exact charge will depend on the size of the retirement fund.

He says most smoothed bonus funds offer both smoothing and a guarantee on capital - anything from 50% to 100% of capital - at a cost of between 0.8% and 1.5% a year.

While the guarantee fee is paid annually, Sygnia's back-testing of a multiasset fund, using returns of major South African indices over the past 30 years, shows that the guarantees were almost never necessary, he says.

A multiasset fund no more than 60% exposed to equities, and using Sygnia's smoothing methodology, would have delivered annual smoothed returns that were positive over all rolling 12-month periods for the past 30 years, recording only one quarter of negative monthly bonuses.

Hufton says during the first quarter of 1988, following the 1987 Black Monday market crash in the US, monthly bonuses would have been -1%.

Smoothed bonus portfolios have been criticised for a lack of transparency about the returns held back and bonuses declared.

Hufton says Sygnia's smoothing formula is transparent - the standard is to deliver inflation (as measured by the consumer price index) plus 5% over rolling three-year periods. If the returns are higher than this, some of the return may be held back to improve returns that are below CPI plus 5%.

Vawda says 27four believes a capital guarantee is an integral part of a smoothing strategy because without it workers do not have protection from market downturns after events such as 2008, the collapse of African Bank or the Steinhoff collapse.

Members are looking for protection in the years when the market is down 40% because those are the times when insurance is necessary and smoothing is not able to ensure there are no negative returns, she says.

She says 27four's guarantee on 80% of capital costs between 0.6% and 0.7% a year.

Vawda says retirement funds that make use of smoothed bonus strategies typically offer only this investment strategy to members regardless of their age or salary.

27four offers members a choice between the smoothed bonus strategy and a range of portfolios suited to younger members who need investment growth with targets of inflation plus 3% to inflation plus 7% a year.

Sygnia is offering its smoothed bonus strategy to standalone funds rather than pooling all the funds using the strategy in a single fund so the smoothing applies independently within each fund, Hufton says. Individual members will not face any adjustments to their investments (market-level adjustments) when leaving the fund. These are only applied if the retirement fund as a whole decides to move asset managers.

How a smoothed bonus fund works

• The principle behind smoothed bonus funds is that they hold in reserve a portion of the returns during periods of stronger performance for use when returns are weaker, giving you a smoother investment outcome.

These funds declare monthly bonuses, which are adjusted up or down depending on the level of the smoothing reserves.

Smoothed bonus funds are typically offered with a capital guarantee on anything from 50% to 100% of the amount invested.

This guarantees that you will never lose more than the percentage agreed - or none of it.

However, the guarantees incur an additional cost - up to 1.5% a year.

Asset managers also charge for smoothing returns - this fee can be in the asset management fee or in the capital guarantee charge.

Just 1% more in fees can have the effect of reducing your retirement savings by as much as 30% when this fee is compounded over 40 years.

Smoothed returns are calculated over the term of the investment.

Early withdrawals can compromise the smoothing reserves and hence returns for remaining members or investors.

Smoothed bonus funds therefore often apply a market-level adjuster that reduces the bonuses declared to investments that are withdrawn early.