How employers can protect vulnerable employees' retirement savings

Pavit Ramnarain

Given the volatile nature of local markets in recent years, smooth bonus funds have increased in popularity among cash-strapped South Africans seeking a more stable ride to retirement. This most likely shows that South Africans, especially those who are most vulnerable, are opting for all the protection from market volatility that they can get.

The results from the latest Momentum / UNISA Consumer Financial Vulnerability Index (CFVI) reveal a worsening trend across all indicators of financial vulnerability. In light of this, Pavit Ramnarain, Actuary at Momentum Corporate, believes that employers and retirement fund trustees could protect retirement fund members by offering them the best possible investment solution for their retirement savings – both in terms of capital guarantees and highly competitive fee structures.

“We believe that a combination of low financial literacy and capability levels, as well as poor consumer financial behaviour, are the core underlying reasons for financial vulnerability – a term that refers to a sense of insecurity or inability to cope financially.

“However, given the increasingly volatile local market environment, it is understandable that saving for retirement can often be pushed out as a last priority for many. It is therefore critical that all members, but especially those who are particularly vulnerable, be given the best possible chance of achieving their retirement and investment outcomes.”

This belief, Ramnarain says, is very much aligned with the intentions of the new retirement fund default regulations, which are intended to steer retirement outcomes in the right direction. “By requiring trustees to offer members a default investment portfolio that is not excessively complex or unreasonably expensive, these new regulations will assist in providing cost-effective and value-for-money investment solution to fund members.”

“Financially vulnerable employees tend to be more risk averse, largely as a result of financial insecurity and distrust. It is crucial that a default investment portfolio for these members provides an opportunity to generate inflation beating returns to maintain the purchasing power of their savings while at the same time offering at least a capital guarantee to protect them against adverse market movements. An investment portfolio that is able to offer both at a lower cost than other solutions will mean that more money can be channeled towards members’ accumulated retirement benefit” adds Ramnarain.

Ramnarain believes that a new generation of smooth bonus portfolios is required. “The process of smoothing essentially holds back some of the returns in a reserve when markets are doing well and releases these reserves when markets are performing poorly – minimising the impact of market volatility for as long as the member is invested,” he says.

However, considering the steep fees and costly guarantees that are typically associated with smooth bonus funds, a new-age product would need to be designed specifically to protect the most vulnerable employees by offering all the benefits of smoothing, a 100% guarantee, but all at the lowest cost possible.

Ramnarain says the high capital charges come down to the expensive nature of providing investors with a guarantee on the money they invest (referred to as the “capital” amount) and on part of or all future bonuses. “These guarantees, while integral to capital protection when the market is not performing, can be so expensive that they actually end up eating into returns, because the capital charges are normally deducted from your growth,” he says.

Ramnarain says investors need a high capital guarantee now more than ever. “A 100% capital guarantee is essentially a shield from loss, no matter what happens in the market. This means that if an investor were to exit a smooth bonus fund at benefit payment stage when markets are at a low, they would be guaranteed to get 100% of the money that they had invested together with any guaranteed bonuses that were declared.

“Without this guarantee, the unfortunate and untimely occurrence of a benefit payment (death, disability, resignation, retirement or retrenchment) during a market slump could have a serious effect on the financial future of both the member and their dependents.”

Ramnarain says that new-age smooth bonus funds need to drastically reduce capital charges while still providing for a 100% capital guarantee. Costs should be further reduced by combining passive, smart-beta and active investment strategies. Smart beta emulates the lower costs of passive investing while still capturing some benefits of active management. However, this should not come at the cost of any benefits of smoothing.

“By reducing the capital charge and applying a combination of investment strategies, the total cost of the fund will be reduced, which means more money can be channeled towards members’ accumulated retirement benefits. The fund should also be underpinned by a proven investment track record. Although past returns are not an indication of future performance, the underlying investment portfolio should be delivering solid investment performance. A low cost, high guaranteed smooth bonus fund is exactly what the most vulnerable members need,” he says.