The Seven Failures of Treasury's Revised Default Portfolio Regulations

National Treasury’s retirement reforms appear to have lost their way. The promise, to transform the retirement fund system to better serve investors, has been broken. Definitive and well-considered default portfolio rules has been diluted into vague guidelines. Rather than protect savers who are invested in default portfolios, the revised draft regulations protects the status quo and the industry’s vested interests.

The interest of retirement investors – who ultimately own the assets managed by this industry - remain secondary. Which means that most South Africans will continue to be invested in complex and expensive products that deliver poor value and poorer retirements.

Treasury has failed investors on seven key points. We offer a detailed view below, but for a quick view, read the executive summary.

Download The Executive Summary (Pdf)


National Treasury’s first set of default regulations followed through on the 2012 Budget intent, that our “retirement system serve the needs of South Africans better and more fairly than in the past, and as efficiently as possible, by providing more appropriate products.”

This simple mission statement encapsulated both the problem and the objective, what is lacking, and what is needed. Ignore the polite qualifiers and the instruction is plain: provide products that serve the needs of investors, and that are fair, efficient and appropriate.

The retirement fund industry does not voluntarily provide such products; it requires regulations, to ensure that savers who lack the skill, or the will, to make informed financial decisions are defaulted into a suitable product.      

Many retirement funds already offer a default portfolio but the Finance Minister is not satisfied that these are adequate. In his view, “fund boards appear to have given insufficient emphasis to simple initiatives which would substantially improve the retirement outcomes of members of their funds.”

Instead, members have been automatically enrolled into “investment strategies that have complex and high charges, complex policy conditions, exit penalties and/or expensive guarantees.”

Treasury could not have set the parameters any clearer.

The rule of law principle

And there’s the rub. The retirement industry does not like clarity. It thrives on confusion and complexity, on opaque reporting and on nebulous promises that it can immediately nullify with disclaimers. It does not offer “appropriate” products for a reason: the sharing of (finite) investment spoils between investors and providers is a zero-sum game. Products that serve customers more automatically serve the industry less.  

We can infer the industry’s heavy push-back from the many retractions in the second draft. All the important protective measures from the first version were repealed, leaving fund members no better off than before. The watered-down mission statement now merely seeks to ensure “that retirement savings are invested in a prudent and cost-effective manner, and that members get better value for their money.”

Underlining Treasury’s surrender, the revised draft “establishes a better balance between principles and rules than was proposed in the first draft of the default regulations.”

A regulation implies an “authoritative rule” (Merriam-Webster) that can be applied objectively; the application of principles requires subjective judgement. It is already a well-established principle that Trustees should act in the interest of members; this automatically extends to the design of the default portfolio.  But Treasury knows that this principle is not applied, partly through neglect but also because trustees rely on service providers who prioritise their own interests.


Rules are needed where professional judgement is lacking, and it is lacking in most trustees. That is not our view, that is the view of National Treasury itself, put forward in the Explanatory Memorandum for Regulation 28.

“An important consideration is the level of expertise on boards of trustees and their ability not only to make investment decisions, but also to delegate certain tasks (but never their ultimate responsibility) to advisors like asset managers, asset consultants and risk consultants. To the extent that trustees are inadequately informed of investment and liquidity requirements, governance and risk management, the regulation must give stronger direction through rules rather than guiding principles.”

There is an obvious contradiction here, that Boards cannot be trusted to implement prudent portfolios, but they can be trusted to implement prudent default portfolios.

So why the contradiction? Not unintentionally, Reg 28 facilitates the market for government debt and other economic ‘imperatives’. In theory, Treasury also has a vested interest in the design of the default portfolio, to reduce the pension gap and ease the state’s financial burden.

But this only holds if our law provides for compulsory preservation. Without compulsory preservation, there is no real incentive for government to pursue better outcomes.

We can safely say that compulsory preservation won’t happen. The confusion, opposition and capitulation on aspects of the 2016 retirement reforms are still fresh in everyone’s mind, and Treasury won’t revisit this any time soon. Without compulsory preservation, the retirement reform process is highly diluted, and the design of the default portfolio matters less to government.

Yet it still matters to investors, and they have been denied much-needed protective measures.    

Retirement annuity funds excluded

The first draft covered all retirement funds, including RA funds. That was critical, because many of the restrictions protected RA investors.

These are the most vulnerable investors, usually without any relevant financial education or insight.  These people are most in need of defaults that meet their true needs and consider their “likely ability to understand complex benefits, charges and policy conditions”.

For example, the first draft provided that, inter alia, the benefits due to any member in the default portfolio should “not depend on that member’s…withdrawal from the fund or the reason for such withdrawal”. This would have curtailed one of the biggest obscenities in the South African retirement landscape, the early termination charges levied by life insurance companies on RAs. This won’t happen now. Hundreds of thousands of savers will continue to buy these expensive, inflexible and punitive products, unaware of the implications. The life insurance industry will continue to plunder their savings with impunity.

In Discussion Paper A (“Charges in South African retirement funds”, 2013), Treasury readily admits that “performance fees are extremely complex, and few retail investors have the ability to assess whether the basis for the calculation of performance fees bears any relation to manager performance.”

Treasury explicitly acknowledges the vulnerability of retail investors, yet denies them the protection these default regulations would have provided. The ultimate irony is that RA investors are the only group of fund members who ARE subject to compulsory preservation, before and at retirement.  

Performance fees permitted 

The first draft regulations had an outright ban on performance fees, and for good reason. The use of asymmetrical performance has been discredited internationally, and is even forbidden in US mutual funds. Morningstar, in its 2015 Global Fund Investor Experience Study on South Africa, expressed misgivings about this ubiquitous South African practice.

Yet Treasury appears to concur with the industry objections that performance fees incentivise asset managers to outperform the benchmark, and that they are a great way to share risk between fund managers and members.

Yet this directly contradicts what Treasury said in its Discussion Paper A: “Investors are often persuaded to accept performance fees on the basis that they align the incentives of investment managers with their investors. In practice, however, there appears to be little reliable evidence that even well-constructed performance fees improve manager performance.”

There are many factors that discredit performance fees, not least of which is that the calculation of performance fee is complex and opaque. David McCarthy, former retirement policy specialist at National Treasury, famously remarked that even his PhD from Wharton School did not equip him to understand how some providers calculate theirs.

Default portfolios must be cost-effective rather than low cost

What is “cost-effective”? Every online dictionary offers a different definition. Treasury has its own unique interpretation, referring to fees that are “reasonable and competitive”. That is most unhelpful: in an industry that does not compete on fees, charges that are high in absolute terms may still appear reasonable and competitive on a relative basis. Four years on, Treasury’s damning discussion paper on charges in South African retirement funds, and the dramatic impact of fees on the long-term savings outcome, appears all but forgotten.

However, we would argue that “cost-effective” immediately disqualifies active managers from the default portfolio. Active funds, in aggregate, only earn the market return, just like passive funds, but they are far more expensive. That cannot be “cost-effective” under any definition.      

Alternate asset classes

Another reason why performance fees were allowed back in is that “international investment and alternative asset classes such as private equity, infrastructure and hedge funds would be inadvertently excluded from consideration”.

Except there was nothing inadvertent about this. Treasury deliberately sought to exclude complex and opaque investments that charged excessive fees. This is the epitome of “alternate asset classes”. We challenge any retirement fund trustee, professional or otherwise, to give a proper account of the workings and charges of such investments.

These types of investments are worthwhile for those who own and manage them, but less so for those who invest in them. Of course the industry did not want them excluded. If Treasury can’t see through the marketing hype, what hope is there for trustees?  

Existing defaults not required to conform  

Another astonishing about-turn: default arrangements in place before the regulations come into effect will be exempt from complying. This is despite Treasury’s admission that “in many cases, members have been automatically enrolled into excessively complex, unreasonably expensive or otherwise inappropriate default investment portfolios.”

There is simply no good reason to exclude these funds, other than to protect the industry’s interests. But was the goal not to protect the members’ interests?

Guarantees and smooth bonus policies

Although the first draft did not prohibit the use of smooth bonus policies, the typical smoothing of returns between different generations would have limited their use.  

Yet these policies now qualify specifically for inclusion in a default investment portfolio, subject to some provisos. Again, we challenge any retirement fund trustee to give a proper account of how these products work, how much they really cost and what benefits are due to any member at any time.

Treasury knows very well that such complexity does not serve investors, which is why the first draft advocated simplicity. The more convoluted the product, the more likely that investors are (over)paying for features and protections they don’t need.  

So what does the default portfolio 2.0 look like?

In summary, the default portfolio must be “appropriate” for members. It requires clear communication on composition and performance, be “cost-effective” and transparent on fees and charges, consider both active and passive investment styles, and not permit loyalty or other “complex” fee structures. Members must not be locked in, and the portfolio must be reviewed regularly.

Given Trustees’ fiduciary duty, we would expect all retirement fund portfolios to meet these basic requirements. Surely, the default portfolio demands something more, at least a clear indication of what Treasury’s considers “appropriate”, “cost-effective” and “complex”.  

These principles are vague and subjective. The only way to test the trustees’ interpretation, and to create proper guidelines, is in a court of law. But which investor is willing to go down that route?

Five years wasted

The Explanatory Memorandum concludes that “the regulations seek to largely promote simplicity, transparency, disclosure, good value products, member protection, and to ensure that the board of a retirement fund always acts in the best interest of fund members.”

The default regulations were meant to enforce these features, not promote them. It appears that Treasury’s retirement reforms have lost their way; what started out with a series of well researched papers and proposals promising savers a better deal, has been diluted into a few vague guidelines. Unless there is a complete about-turn in the final version, this will become just another box-ticking exercise. A few superficial tax changes apart, the entire reform process will be a complete non-event.

The retirement industry won’t have to change. The status quo remains intact, the industry’s vested interests are safe. The concerns of retirement investors – the owners of the assets managed by this industry - remain secondary. The great majority will continue to be invested in complex and expensive products that deliver poor value and poorer retirements. This is what happens when offenders get to adjudicate their own trespasses.

But while Treasury may have been forced to submit to industry pressure, there is no reason for trustees to do so. Irrespective of what the final draft regulations say, Treasury’s true position on this subject is still a matter of public record: the first draft sets out exactly what it believed to be industry best practice, and what it deemed to be unacceptable in the default portfolio. This should be the first point of reference for trustees who really want to do right for their fund members.

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