Retirement funds: let’s talk about the elephant in the room
Why the industry won’t do more to look after investors
There’s an elephant in the room. Not the Indian one – that one appears to have left the building. We want to discuss the African variety. It’s larger, louder and potentially more dangerous, and it likes to charge – a lot.
Much has gone wrong in our country these past nine years. In essence, there’s been a wholesale failure in governance. Public officials were allowed to trample on the norms of our democracy, permitting and exploiting conflicts of interest, and neglecting to hold the responsible parties to account.
If there’s one positive to this, it’s the way society and our media mobilised to bring all this to light. It’s a reminder for all of us to be vigilant about potential abuses. As Jon Stewart, former host of The Daily Show, put it: “When you smell something, say something.”
In that spirit, the African elephant we want to sniff out here is the retirement fund industry – or, more specifically, the way its poor stewardship contributes to the high failure rate among retirement savers (only a fraction of even our working population can look forward to a comfortable retirement).
The national Treasury suggested as much when it first spoke of retirement reform and sought a system that “serves the needs of South Africans better and more fairly than in the past, and as efficiently as possible, by providing more appropriate products”.
If we strike out the polite qualifiers, the Treasury’s views on the subject become plain: it wants the retirement industry to look after investors more than it looks after itself by offering products that are “fair”, “efficient” and “appropriate”.
That begs the question: why wouldn’t the industry do so on its own? But it doesn’t. It was for the same reason that the Financial Services Board was forced to launch its “TCF” initiative, compelling the industry to treat customers fairly.
The problem lies in the conflict of interest that runs through the industry. It exists because the industry lives off the money put up by investors, by pocketing some of the investment returns for itself. The more it keeps, the less investors get.
The industry delivers some essential services for which it deserves a fee. However, in its stewardship role it must recognise that the available return is finite and diminished by those fees. It is essentially a zero-sum game: if service providers maximise their income, it is at the direct expense of investors’ living standard in retirement.
If the industry took its stewardship role to heart, it would establish a fair balance between the two. Yet many of its practices are self-serving – rewarding owners but costing clients billions of rand in unnecessary fees every year.
Stewardship or salesmanship?
These clients are entitled to a fair share of the investment return. They put up 100% of the capital and take on 100% of the investment risk. Fees eat dramatically into that return. Over a 40-year savings term, an additional 1% per year in fees can reduce the savings outcome by 20%–25%.
Some retirement annuity funds charge as much as 3% per year, leaving clients with 40% less money than they could have had with a low-cost alternative. Even though the industry is well aware of the long-term fee impact, it continues to provide and market these products to unsuspecting investors.
One reason some funds’ fees are so high is because they pay for expensive “active” fund managers. These offer the possibility (but no guarantee) of an above-average investment return.
By contrast, low-cost providers typically rely on indexing, a mechanical investment process that captures the average market return. The evidence overwhelmingly shows such funds are more appropriate because they beat most actively managed funds, even more so once fees are considered. They also eliminate the risk of investing with a manager who massively underperforms the average market return.
Notwithstanding this evidence, the industry’s chain of service providers – consultants, financial advisers, administrators, asset managers and even fund trustees – continue to advocate actively managed funds, not because it serves their clients, but because it’s more profitable for themselves.
The real money fight: the elephant in the room
10X CEO Steven Nathan, S&P's Zack Bezuidenhoudt, radio host Africa Melane and comedian Siv Ngesi talk about some of the issues the investment industry doesn't want to.
Compounding the stewardship deficit is the amount of investment choice on offer. There are now more than 1,600 unit trusts available to local investors, with some fund houses offering two dozen different funds or more. Rather than “sell what we make” – which, efficiently, would be their best investment view – they make what is likely to sell, irrespective of whether it serves clients’ interests.
Fund administrators enable this by offering their members investment choice, even though many are unable to make informed decisions on their own. For them, such choice and complexity manifest in higher admin charges, advice fees, emotional investment decisions and misguided switching. It keeps brokers and advisers in business but does not improve their returns.
It was John Bogle, founder and former CEO of The Vanguard Group, now the second-largest asset manager worldwide, who said that “maximising profits is right for most businesses, but it’s not right for this business”. Notwithstanding, our retirement industry persists in advocating products that boost its own profits at the expense of its clients’ pensions.
South Africans are hopeful that our new leadership portends a return to governance that will help turn the country around. It is probably expecting too much for the retirement industry to go with the spirit of the times and embrace its stewardship responsibilities more fully. But it shouldn’t be, if the alternative course is to deal with the backlash from what is likely to be increasingly informed and vigilant investors.
About 10X Investments
In an industry famous for mammoth promises on a large, confusing array of products, most of which disappoint, 10X uses a simple, proven strategy to give investors the best possible chance of reaching their retirement investment goal: invest 15% of your income for 40 years in a high-growth index fund and pay fees of 1% per year or less.
10X relies on index tracking to deliver the returns of the market as a whole. Fees are a valuable tool for predicting future investment performance and the fees on its retirement annuity are less than half the industry average. It invests in a mix of shares, property, bonds and cash to maximise growth and automatically adjust portfolios as savers get closer to retirement to reduce risk.
Already got a retirement annuity? Nine out of 10 investors could do better with 10X.
This article was paid for by 10X Investments.