Investing in a smoothed bonus portfolio means you pay more for protection from market losses. Picture: 123RF/RAWPIXEL
Investing in a smoothed bonus portfolio means you pay more for protection from market losses. Picture: 123RF/RAWPIXEL

The declaration of a negative bonus on a large insurer’s smoothed bonus portfolio after the recent stock market fall, has left the local retirement fund industry a little stunned.

It has been many years since any large smoothed bonus provider has removed bonuses — they remained intact after the 2008 financial crisis — and Fedsure was the last big insurer to do so, back in 1999.

Old Mutual says technically it did not remove any bonuses this time either — in its words it applied a negative bonus rate — but the effect was to remove 5% of the value of investors’ funds in the portfolio in April, amounting to an estimated R6.7bn. The life company believes it was the best way to be fair to all investors.

Its main competitors in the smoothed bonus investment market, Sanlam and Momentum, did not remove bonuses or declare negative ones, leaving the savings of members who retired from funds using these portfolios intact. 

Investing in a smoothed bonus portfolio means you pay more for protection from market losses such as the 10%-15% losses retirees who were fully exposed to investment markets experienced after the March market crash. Many South Africans seem to  prefer this protection with these portfolios growing to close to R190bn by the end of 2019.

Costs drive use of partial guarantees

If it is possible to invest in a portfolio that offers a 100% guarantee on your savings and the returns you earn, why isn’t this option more popular?

The answer is that the higher the guarantee, the more it costs you. 

Retirement fund consultants are advising retirement funds to use partial guarantees because they are cheaper and because recent experience until now has been that they have always delivered positive or 0% returns, Danie van Zyl, head of the smoothed bonus centre of excellence at Sanlam Corporate, says. 

Fred van der Vyver, the head of group retirement and guaranteed solutions at Old Mutual, says Old Mutual charges 0.2% a year for the 50% guarantee on the Absolute Growth smoothed bonus portfolio and 0.7% for the 80% guarantee. With a 0.55% asset management fee, it brings the total investment cost to 0.75% or 1.25%, he says. 

Van Zyl says the Sanlam Stable Bonus portfolio charges 0.9% for the guarantee and 0.42% for asset management, bringing the total investment cost to 1.32%.

In contrast, the charges for the 100% guarantees are 1.8% on Old Mutual’s Core Growth 100 and 1.6% of the Sanlam Monthly Bonus.

In the past smoothed bonus portfolios were criticised for investing too conservatively, having high charges and for smoothing mechanisms that were unfathomable to all but the actuaries who devise them.

The country’s most popular smoothed bonus portfolio, Old Mutual’s Absolute Growth Portfolio, therefore now invests 65% of the fund in local and global equities and has 15% in private equity. Holding R134bn, this fund dwarfs its nearest competitors’ biggest portfolios of R12bn (Momentum) and R10bn (Sanlam). 

This Old Mutual portfolio is only partially guaranteed at two levels — either 50% or 80% of your savings is guaranteed at all times but the remainder can fluctuate with the market. It also has rules when to declare negative bonuses, Fred van der Vyver, the head of group retirement and guaranteed solutions at Old Mutual, says.  

The protection you enjoy in a smoothed bonus portfolio is funded by reserves — the pot of money the life company manages by withholding some returns when markets run hard to boost them in times when markets perform badly. But when markets fall very hard as they did in March, these reserves can fall below what is needed to fund the smoothed values.

 

At times like these, assurers either have to use the company’s shareholder money to support the portfolio and declare low bonuses for everyone for the months ahead to recoup that money, or remove some of the bonuses previously granted to investors but which were not guaranteed — in older smoothed bonus portfolios these were called the nonvesting bonuses.

Van der Vyver says everyone who signs up for a smoothed bonus portfolio agrees to some cross-subsidisation. But he says Old Mutual believes there is a limit to which investors should share in any underfunding. 

He says declaring a negative bonus — together with some market recovery — have helped restore the fund’s reserves and the Old Mutual fund is positioned to do better.

“We are in a good position to quickly declare higher bonuses in the year ahead, while all else being equal other portfolios that did not declare a negative return may take longer to get to better bonuses,” he says. 

The Old Mutual portfolio may also have an advantage if equities recover well as it has a higher exposure to shares, he says.

But Danie Van Zyl, the head of the smoothed bonus centre of excellence at Sanlam Corporate, says declaring a negative bonus is just too drastic a step, especially considering the sharp recovery in April, and one that Sanlam has never taken. There are too many nuances to predict confidently which portfolio will recover better; a lot depends on the performance of the different asset classes and stocks within them to which each fund is exposed, he says.

In May and June Sanlam declared a 0.2% bonus for those paying the highest fees on its Stable Bonus portfolio. Old Mutual declared 0.14% in May and 0.29% in June on its Absolute Growth Portfolio with the 50% guarantee. 

The different approaches have resulted in a marked difference in short-term performance — over the year to the end of April, the Sanlam Stable Bonus has a return of 6.9% before investment fees while the Old Mutual Absolute Growth has a return of either 0.2% (for the 50% guarantee) or -0.2% (for the 80% guarantee).

Over a much longer 10 years, the Old Mutual Absolute Growth portfolio with the 50% guarantee has delivered 10.7% a year while the Sanlam Stable Bonus has delivered 11.1%. 

Both insurers also have much less popular portfolios that offer a 100% guarantee on capital and returns and will therefore never have negative returns. The Sanlam Monthly Bonus has delivered returns of 10.1% a year over the past 10 years, while the Old Mutual Core Growth 100 has returned 9.9% a year over the same period.

Van der Vyver says the past 10 years include the past very unusual five-year period of poor returns from the JSE which has favoured more conservative funds, but ordinarily a higher equity exposure should deliver higher returns over the long term.


Who should use a smoothed investment?

Retirement fund trustees are increasingly choosing smoothed bonus portfolios as the default investment option for members who do not want to make their own investment choice. 

This is especially the case in umbrella retirement funds that offer a single cost-efficient fund to multiple employers with employees from different sectors.  Some umbrella funds use smoothed bonus portfolios as the default for members of all ages. In other cases, smoothed investments are the chosen option only for members close to retirement. 

Old Mutual’s Fred van der Vyver says as member of Old Mutual’s Superfund Choice Umbrella Fund in the smoothed lifestage default investment option your savings will start in the Absolute Growth smoothed bonus portfolio with a 50% guarantee, moving to the portfolio with an 80% guarantee seven years before your retirement date.

Three years before retirement you will be fully invested in that portfolio, protecting 80% of your savings from a market fall shortly before retirement, when you have less time to wait for a market recovery. 

The Old Mutual Superfund Easy Umbrella Fund aimed at smaller employers makes use of the smoothed bonus portfolio with the 80% guarantee as its default for all members. 

Sanlam’s Van Zyl says Sanlam has four default options of which three transition from six years before retirement for the next 50 months into the smoothed bonus portfolio. Though retirement savings are intended to be for the long term that should give you enough time to ride out the ups and downs in the market, in reality members draw their savings on death, disability, retrenchment and resignation and smoothing can protect you if any of these events occur.

Sanlam believes a smoothed bonus portfolio is a good idea both before and after retirement when retirees are using a living annuity to draw a pension. New retirees are most at risk of permanently damaging their capital’s ability to support their pensions if they earn poor returns shortly after retirement, Van Zyl says. This is known as the sequence of returns risk and can permanently affect your future pension. 

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