Smoothed bonus investments aim to allow you to invest a little more aggressively in shares. Picture: 123RF/EM EVIL
Smoothed bonus investments aim to allow you to invest a little more aggressively in shares. Picture: 123RF/EM EVIL

Retirement funds that offer smoothed bonus investments are, in future, likely to tell you a lot more about the calls they make on these products when they offer them as default investments. 

However, after the increased disclosure that the regulator, the Financial Sector Conduct Authority (FSCA), is likely to require for compliance with a new conduct standard, it will be up to you to weigh up the costs against the benefits.  

Smoothed bonus investments promise to smooth your returns so you are not subject to sharp falls in your investment value. The idea is to keep back some of the returns earned when stock markets do well and to pay it back to you when markets don’t do so well, so you get a smoother ride. 

If you are a long-term saver, you should be able to stomach the ups and downs as it is the cheapest way to get the greatest benefit from the investment markets. But smoothed bonus investments hold R180bn of money for investors who are spooked by their investments showing short-term losses on their statements and those who are likely to draw their retirement savings in less than five years.

Smoothed bonus investments aim to allow you to invest a little more aggressively in shares but putting smoothing and guarantees in place to protect you from sharp falls. It sounds like a good idea, but in practice the products are complicated and investors have, at times, felt they have been treated unfairly. 

The conduct standard also tries to prevent life companies withholding good returns longer than they should or taking their time to pay them out to you

For this reason, the FSCA has published a conduct standard that obliges providers to tell you a lot more about how they will smooth your returns in a default investment option or default annuity offered by your retirement fund. 

While the trustees also have a duty to consider whether these options are appropriate for you, you would do well to pay attention to the disclosures.

To smooth returns, assurers run two accounts: one reflecting whether the market value of the money they invested on your behalf — called the funding reserves; and one reflecting your smoothed investment or book value. 

When they add returns to your investment they do so by way of bonuses and only a portion of that bonus is definitely yours — it vests. The rest is “non-vesting” and can be taken away if the markets fall and the money invested on your behalf falls materially below the smoothed balance. 

Most life assurers try not to remove bonuses — after a market fall they just declare no bonuses until the fund reserves recover. But after the March market drop, Old Mutual, which has the biggest smoothed bonus funds, declared a negative bonus, effectively taking some of the book value back.

The conduct standard says life companies should explicitly tell you how they will invest, how they will calculate the bonuses and how low the funding level must be before they will remove your non-vested bonuses. 

The conduct standard also tries to prevent life companies withholding good returns longer than they should or taking their time to pay them out to you. It says that, long term, the funding levels should be no more than 105% and any surpluses can’t be spread over a period of more than two years.  

Another practice the conduct standard attempts to shine a light on is the way in which reserves are increased when they are below what is required to pay you out. The standard says life assurers must tell you upfront if they will “lend” shareholders’ money to the fund to boost the reserves then recoup that loan from your future returns or if they will, in fact, subsidise returns. 

Andrew Crawford, CEO at pension fund consulting firm Seshego Consulting, says that in more than 30 years in the industry he has never seen shareholders subsidise the reserves. The reserves have always been restored by declaring lower bonuses in future, and these low bonuses can persist for years, he says. 

However, Chris Cooke, marketing actuary at Momentum, says the company has used shareholder funds to boost the funding reserves and did so in March when markets fell sharply.

Guarantees

Some life assurers say smoothed returns can show big losses, and provide different levels of guarantee, for example 50%, 80% or 100% of your capital plus bonuses. The greater the guarantee the higher the cost, about 0.2% for a 50% guarantee and up to 1.4% for a 100% one. 

One percent may not sound like a lot, but just 1% more in fees can reduce your savings by more than 20% if the fee is compounded over 20 years. The regulator’s standard says you must be told what the charge for a guarantee is.

Cooke says the costs of the guarantee are calculated based on the probability of the life company having to use shareholder funds to top up the reserves. The regulator also requires insurers to hold reserves when writing such products, and the funding of these reserves also costs money.

Crawford says you should remember that the guarantees only apply if you take your retirement benefit at the point the markets are down, adding that the chances of that are quite remote.  

Meanwhile every member in the smoothed bonus fund pays the inflated charges for the few that retire when the markets are down, says Crawford, who believes there are better ways to protect yourself against these market falls.

Typically, retirement funds give you the option to move to investment options that reduce your exposure to risky shares when you can’t afford to take investment risk.  

Crawford says members of umbrella retirement funds that cater for members from many different employers are increasingly being offered smoothed bonus portfolios instead, but these are “poor value investments where the gross returns become significantly lower after taking off these charges”.  

Sygnia recently launched the Stabilised Growth Fund without the expensive guarantee — only smoothing. The fund’s worst monthly bonus over the past nine months was -1% in April, following the market fall in March, and monthly bonuses have since been from 0.24% to 0.71%

The alternative view

Cooke says smoothed investments suit members who prefer to only see their savings growing without any losses, and who get very uncomfortable with negative returns even if they are long-term investors.   

He says the smoothed bonus investment allows investors to maintain higher exposure to the stock market, hence potentially earning higher returns, while experiencing a smoother investment journey and having guarantees on their accumulated capital. This offsets the higher cost, he says. 

Momentum believes that, despite the costs, the investments are valuable to members as they approach retirement and do not have time to recover from investment losses.

Cooke says a partially vesting smooth bonus solution, with, for example, 80% exposure to growth assets such as equities and listed property, can earn returns materially more than a low-equity, multi-asset class portfolio with, for example, 40% in equities.

After costs, your returns from the smooth bonus solution are expected to be higher, and in addition, your investment would be less volatile and you have guarantees that ensure you get the full, smoothed benefit should you resign, retire, become disabled or die.

The products are also useful for retirees who use investments in an investment-linked living annuity to provide a pension. Negative or poor returns in the early years of retirement can be devastating. This is known as the sequencing of returns risk. 

Smooth bonus portfolios provide an investor with a very good solution to mitigate such risk without having to allocate excessive capital to lower-returning, “safer” asset classes. This is particularly the case when you are drawing a pension that is higher than 4% of your savings (R333 a month for every R100,000 you have saved). Four percent is the level regarded as low enough to allow your savings to sustain a pension for the 20 or 30 years you may live in retirement.  

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