In such an environment, says Rodney Msimango, senior investment consultant at Old Mutual Corporate Consultants, selecting the right investment management approach is paramount in ensuring that retirement funds achieve the desired outcome of financial security, despite the current local and global market volatility.
“Differing considerably in terms of fee structure, volatility and complexity, each investment management strategy is expected to perform better during different market conditions and, as such, the choice of strategy should depend largely on the specific members and what is most appropriate for them,” says Msimango.
“To do this effectively, a clear understanding of each investment management strategy and their fundamental differences is required,” he adds.
Cost is one of the differentiating factors. “Passive or index-linked funds undoubtedly have the lowest fees in both the retail and institutional space. Actively managed funds are more expensive, but if competitively priced can still provide clients with value if the managers can exploit inefficiencies in the market and deliver superior returns in excess of their additional cost.”
“Using a smoothed bonus approach is more expensive than index-linked funds as this investment strategy generally incorporates active management while also controlling volatility and offering clients’ investment guarantees to protect them from adverse market movements,” Msimango explains.
For its part, multi-management simplifies the investment world and the process of selecting the most appropriate investment managers for clients while also mitigating the obvious risk that comes with selecting one single manager who may fail to perform as expected. A multi-manager will also cherry-pick the specialist skills within the asset management industry to secure the outcomes.
“There will always be a debate about fees but what is important is for members to weigh up net returns against the fees to ensure they are getting what they pay for,” he says.
The level of exposure to volatility members should embrace is another consideration when selecting an investment strategy. While exposure to volatility is unavoidable when investing in growth assets, Msimango points out that members’ time horizons should play a big role in determining how much volatility they can tolerate. Volatility can have a very significant impact if clients are forced to disinvest at an unexpected point in time.
He adds: “People generally think about volatility pre-retirement, but the level to which they embrace volatility should largely depend on what they plan to do post-retirement and whether they are planning on taking cash or purchasing a life or living annuity. If an investor may be forced to disinvest when the markets are down, a smoothed bonus approach could be more appropriate.”
The last differentiating factor is member understanding. “In an environment where members are encouraged to take ownership of their retirement savings, member understanding becomes an important aspect. Whether members are choosing an investment portfolio or are put in to a portfolio by a trustee, they need to understand what it is they are going to get.”
“Members generally understand a single active manager, as they see these managers advertised in the paper and understand that their role is essentially to ‘actively manage’ a fund. Index-linked investments are somewhat less understood. Though people do understand that they will receive market-related returns, they don’t understand that there are various indices to choose from. Multi-managed and smoothed bonus funds, although carrying the lowest risks, are often less well understood by members.”
Msimango adds that a low level of understanding is a driver of poor investment behaviour. “People too often choose a manager based on brand or short-term performance, when they should be basing their choice on long-term objectives, risk tolerance and preferred investment philosophy.”
“Where a client has a long time horizon with a small risk of having to disinvest then an index-linked fund may be the most cost-effective option, while if other factors, such as volatility need to be balanced, then the higher costs of the other options may be justified.”
No matter how much time and effort is spent comparing these investment philosophies, there is no silver bullet approach and each strategy can yield good results during different periods, depending on the given market cycle. “Each strategy has its particular merits and has performed better than the other strategies at one time or another, resulting in a complicated selection process. This is where consultants become invaluable as their ability to understand the clients’ needs enable them to guide clients to select the most appropriate approach and product for their particular member base,” he concludes.
