The intention is not to propose a particular approach but “to assist South Africans in getting the best possible value for the retirement savings they make”. However, reading between the lines, it is apparent that Treasury advocates simple, low cost default solutions using passive investing rather than the complex product options that currently underpin financial intermediaries and high-cost active managers.
The paper has a matter-of-fact tone, but as it unpacks the practices and fees along the “value” chain, it gradually exposes an industry that systematically exploits its clients and decimates the savings of uninformed, misinformed, inert and consequently price-insensitive customers. Nothing in this paper suggests that the industry is even remote concerned about the welfare of savers.
Unfortunately, the document is unnecessarily long and repetitive, with the main themes and findings repeated no less than six times. We are also disappointed that Treasury did not use original research to assess the current industry costs, to make its assessment more authoritative. So it is perhaps not surprising that the media’s response was a bit muted. There were no front page headlines screaming “Grand Theft Pension!” or “SA pensions industry a disgrace”.
Most editors did pick up that an investor paying an annual fee of 0.5% pa will receive double the retirement income as one paying 2.5% (although one publication still seems unconvinced). But 10X has beaten this drum for the past five years already, highlighting the ruinous impact of high charges. Treasury’s paper now confirms this.
The number of 2.5% pa is pertinent as, per the paper, this is the average fee paid by savers in defined contribution commercial retirement funds (umbrella, preservation and RA funds). This number captures some R440bn in savings and 5.4m savers. The additional 2% fee means that the retirement funds industry skims R8.8bn off these investors’ savings – every year!Retirement fund charges
The paper distinguishes between commercial and non-commercial retirement funds. Non-commercial funds (union, industry and stand-alone funds) without investment choice typically only levy one charge for administration (contribution or payroll-based) and one for asset management (asset-based). 10X follows this simple model, even though it manages mainly commercial retirement funds. In fact, the 10X retail products (preservation and RA funds) only charge one all-in management fee.
Members of other commercial umbrella and RA funds are not so lucky, especially if their fund offers investment choice. The paper lists their possible charges: “administration charges, policy fees, benefit consulting charges, financial advisor fees, risk charges, asset management charges, manager selection charges, guarantee charges, capital charges, performance fees, platform fees, and conditional charges when various events, such as switching investments, leaving the plan, or terminating the policy, occur.”
Some charges are levied either as a percentage of salary or contributions, or as a percentage of assets, or as a percentage of the return. Some may be a fixed annual rand cost. Any which way, it all suggests an unchecked feeding frenzy at the saver’s pension pot.What drives charges?
High charges are not just a South African problem, they happen everywhere. But invariably, as with most other international comparisons, local funds feature on the wrong side of the fee comparison table. What is it about our pension industry that drives – and permits – these high fees?
The paper identifies numerous factors to explain the situation. The industry argues that, without compulsory saving and preservation, the remaining participants do not enjoy the full benefits of scale. This is exacerbated by too many small-sized funds.
Treasury sees other reasons. In essence, the umbrella funds market is not competitive. This manifests in poor comparability of product terms and prices, poor portability, low transparency and high barriers to entry.
Neither the level nor the disclosure of fees is properly regulated, enabling providers to manipulate both. Without a standard measure of the cost impact, price comparisons are impossible. The paper argues that providers make it deliberately difficult for customers to compare prices – Treasury identified a “profusion of charges and charging structures” – to avoid price competition.
This complex pricing model necessitates and justifies the use of financial intermediaries, which further inflates costs. Many intermediaries are incentivized to sell the industries’ products, which perpetuates the use of high-cost active asset managers at the expense of passive low-cost investing. This entrenches the incumbents. Uninformed investors are unaware of, and insensitive to the level of recurring charges, and do not push back.
The complexity is exacerbated by flexible fund designs, and by differentiated products and services. The industry offers many options that essentially just disguise close substitutes. This practice reduces economies of scale, raises charges – and again necessitates the use of intermediaries. The industry spin creates a vortex that draws investors in – and under.
New entrants face considerable barriers to entry: a high cost in technology and human resources, captive distribution networks and economies of scale that protect the large incumbents. Fund administrators are deliberately uncooperative and tardy, in order to hamper portability among funds and discourage switching.Flawed pricing and distribution structures
Treasury highlights the problem of charge shifting and price discrimination. The industry sways uninformed employers with low initial charges, and then slaps on high recurring costs. The initial charge has a proportional affect on the savings outcome: a 5% deduction off the contribution lowers the pension pot by 5%. But the recurring charge has a geared affect: a 2.5% pa asset-based fee halves the pension pot after 40 years. So a provider may deliberately undercharge for administration (which is typically recovered from the contribution) in return for higher asset management fees and lucrative cross-selling opportunities (for risk products, annuities and loans).
Some providers understate recurring asset fees by disguising them as performance fees. They do this by using inappropriate benchmarks or soft hurdle rates. As performance fees cannot be quantified beforehand, they are typically not captured in the ‘reduction in yield’ metric used to compare charges across funds. Treasury comes out strongly against even “well-constructed” performance fees, as there is little reliable evidence that they improve performance. The formulas are complicated and the charges difficult to prove. They also encourage fund managers to assume additional investment risk, which prejudices investors.
Another concern is smoothed bonus products, which provide performance guarantees in return for a higher fee. Much of the time, such guarantees are unnecessary, as the perceived investment risk is tempered by time and diversification. Yet the product appears attractive to uninformed – and often low income – investors.
The industry offers many variations on this theme, by varying product features (such as investment choice, guarantees, surrender terms) and prices. The uninformed customer has no way to assess the value or need of these features, and may select unnecessarily expensive products. Or they may be tempted by uncompetitive headline prices to take advantage of “discounts” available through a particular distribution channel.
Of course, such selling practices are not unique to the pension fund industry. However, in no other industry do they have such an insidious effect. These practices are made possible by the knowledge gap between investors and providers, and by the industry’s deliberate poor transparency. After all, it is impossible to quantify the impact of fees, if the fees are not quantified.
The disclosure of costs and charges in a commercial umbrella fund is presently not regulated. As the paper notes drily, this gives “substantial opportunities for imperfect disclosure”. So, for example, no retirement fund – other than 10X Investments – discloses gross investment returns. The FAIS Act does mandate full disclosure of all charges on financial products sold by the intermediary, “but it is unclear how effective this requirement is in practice.”
The paper recognizes that “intermediaries may suffer from conflicts of interest”, as they advise customers but are usually remunerated by product providers. Sales competitions may impair their objectivity and trail commissions (ostensibly in return for ongoing advice) do not represent value as the investor usually does not hear from the intermediary again until it is time to ‘advise’ on another product (for example, when a member leaves the fund).
The industry’s standard distribution model is flawed and contentious, as the customer bears the entire cost. It is highly lucrative as the provider is unaffected by, and the uninformed customer insensitive to, the commission rate or product chosen. Unsurprisingly, advisers generally recommend active rather than passive asset managers, as these tend to pay a higher commission.
The paper also takes issue with LISPs (linked investment service providers), platforms that enable investors to select and switch funds. As their owners often also provide active management services, few offer low cost passive options. Instead, they create a layered charging structure, in which unaware investors may pay two or three providers to make essentially one asset allocation decision. The rebates paid within this investment chain are not transparent, and disguise the true nature of fees deducted.Governance
Governance plays a critical role in protecting members’ interests. The paper tacitly admits that governance has failed. In stand-alone funds, most lay trustees lack the insight or incentive to challenge (often conflicted) asset consultants on fees and recommended products. In most umbrella funds, this conflict resides within the Board itself as the trustees represent the Fund sponsor (the administrator) and therefore act as both player and referee. In both instances, the fund members’ interests are prejudiced.Draft proposals
The paper presents numerous draft policy options. Some are broad, and some are specific to the particular type of fund.
1. Consolidate funds – this will create economies of scale and lower the average cost per member
2. Improve governance – Treasury may seek to impose a duty on Board trustees to fulfill their fund’s objectives cost-effectively; it may also increase the requirement for boards to include independent and expert governance
3. Strengthen regulation – empower a pension industry regulator to monitor all aspects of the retirement system, including costs
4. Standardize fund specifications – this may include standard fund rules, investment mandates, service level agreements and codes of practice
5. Simplify fund design – to increase price competition among funds, tax exemptions may be restricted to simply-designed or standardized funds (simple charging structures, restricted product options, and standard rates for all fund members).
6. Restrict fees – an outright ban on exit penalties, loyalty bonuses, restrictions on performance fees and caps on recurring charges
7. Re-incentivize intermediation – align the interest of intermediaries more closely to that of customers, possibly by reviewing remuneration structures; this will include rebates paid to investment platform providers
8. Mandate saving – require employers to enroll their employees into a retirement fund
9. Create a retirement fund exchange – this will allow smaller employers to compare different plans, without requiring financial advice; to that end, funds listed on the exchange must meet certain criteria in terms of scale, design, efficiency and simplicity
10. Incorporate a clearing house – the exchange may also operate as a clearing house, to centralize collections, fund administration and fund transfers; this may be integrated with SARS
11. Establish a default fund – this will facilitate auto-enrolment for employers who do not specify a fund, and may serve other functions such as facilitating preservation and managing unclaimed benefits
Additional proposals for non-commercial funds:
1. Strengthen governance – legislate the duty of trustees to fulfill the fund’s objectives cost-effectively
2. Strengthen reporting – report ALL charges borne by the fund, the employer, the member or intermediaries to the regulator
3. Strengthen disclosure requirements – standardize fee reporting across funds to make these comparable; these may be based on a TER or RiY method and include allowances for conditional charges
4. Limit investment choice – prescribe the number of options, all of which must meet prescribed criteria; each fund must have a default option that meets these conditions, which will include a simple charging model, a cap on the annual charge and restrictions on performance fees, termination penalties and market value adjustments,
5. Re-incentivize benefit consultants – to align their interest with that of customers rather than service providers; investment managers will be barred from paying rebates to distributors
6. Increase competition – create templates to compare investment products, services and prices
7. Standardise best practice by creating templates on matters such as fund and policy documents, investment choice policies, and service level agreements
Additional proposals for commercial umbrella funds:
1. Standardise and publicise charging structure (rather than charge level) across all umbrella funds
2. Introduce special governance provisions – these may include employer-level management committees with defined rights and obligations, with member and employer representation; disallow fund rules that bind the fund to particular service providers
3. Auto-enrollment – require employers to auto-enroll all employees into a retirement fund, to turn employers into active purchasers of retirement funds
4. Set up a retirement fund exchange – this would allow employers to select funds easily, without the use of intermediaries, and lower distribution costs; the exchange could also function as a clearing house; listing conditions would include that funds are simple and cost-effective
5. Set up a default arrangement – this would be listed on the Exchange and facilitate auto-enrollment, preservation funds and unclaimed benefit administration
Additional proposals for RA and preservation funds:
1. Create default options – these would be similar to the ones proposed above
2. Regulate fees – this could be on the same basis as those levied on commercial umbrella funds and non-commercial funds, ie with restrictions and possible bans on performance fees, early surrender penalties, loyalty discounts and other forms of price discrimination
3. Exempt qualifying intermediaries from FAIS – intermediaries who promote membership of RA funds that mirror the default funds in the other DC funds, and that comply with the conditions relating to charges could be exempt from complying with the FAIS Act, if all the members’ savings are invested in the default fund.10X assessment
Treasury’s paper confirms 10X’s industry experience: that it is heavily tainted by excessive fees, choice and complexity, by poor disclosure and governance, and by conflicts of interest that reveal a complete disregard of the investors’ need.
The 10X business model has been designed specifically around the best interest of investors. In ranking new generation retirement annuity funds, Treasury’s Reduction in Maturity value for Provider D (easily identified as 10X) is, at 10.7% less than half that of the next best provider (23.9%). Treasury notes that provider D “does not sell through intermediaries, offers no investment choice and invests all assets passively.”
10X already complies with all the pertinent recommendations. It offers just one simple solution, and no confusing choices. This is based on life-staging, passive investing and low fees. The pricing structure is simple and transparent – both the payroll and the asset-based fees are disclosed at the member level, both as a percentage and in rand terms. The use of intermediaries is not necessary. The Board is made up of a majority of independent, professional trustees.
This is the default solution appropriate for all retirement investors, and it is ready to be listed on Treasury’s exchange. The draft proposals therefore hold no fear for 10X.
The remainder of the retirement industry will feel threatened and we therefore expect a massive push-back. At a recent POA conference, one of the speakers, representing a large life company, alluded to this: he suggested that average fees were coming down but that it would take the industry up to 20 years to align its structures to a low-fee model.
It is of course superbly arrogant to believe that the incumbents should be given 20 years – half a savings life time! – to reform. The POA speaker will find that once customers leave, costs cutting will not seem nearly so difficult.
But his comment reflects the underlying reality: this industry has become so bloated living “off the fat of the land” (to quote Trevor Manuel) that it cannot and will not respond swiftly of its own accord; it will take many years to unwind all the complexity, to foster a low-cost mindset, and to establish a culture – an industry DNA if you will – that emphasizes the investors’ return, rather than that of shareholders, employees and intermediaries.
And in the end, will the retirement industry really change, or will it merely pay lip service and find other ways to fleece savers?
If Treasury’s message reaches and inspires the target audience – employers, trustees, principal officers, management committee members, conscientious advisors and consultants – the industry will be forced to change.
But if it falls on apathetic, disengaged ears, or is drowned out by the industry’s marketing racket, then savers will continue to suffer a lesser retirement.
In all this, investors also have a personal responsibility, to educate themselves and do the right thing. In the end, they will get what they deserve.