The way forward to improving employee benefit engagement

At what cost? Understanding the link between costs and valueSouth Africa  |  01 June 2014 | Insight

Authors and contributers

Anne Cabot-Alletzhauser

Chris Jones

Costs matter – particularly when they are compounded over the time frame typically demanded by retirement benefit schemes. But until wegrasp the dynamics of the full value chain of delivery to members, we will invariably focus on the wrong debates in our quest to control costs. 

What follows is a three-part study that analyses the problem of costs from three different perspectives: 

More importantly, we also present a few radical proposals to try to move the debate around costs to a more realistic and effective outcome. 

Asset management’s contribution to the cost or value issue1The consulting industry’s contribution to the cost or value issue2Administration costs as they apply to different member needs3

It is time for trustees to rethink what’s really worth paying for.

To some extent, National Treasury’s paper on costs has already set out many of the issues relating to points 1. and 2.

But a brief summary of the key points are important for our discussion here.

If we were to take a snapshot of the charges allocated in a typical, segregated retirement fund at a given point in time, the distribution of chargesfor an average 35-year-old fund member will be as shown in the graph below. In the context of this once-off snapshot in time. Most of the fees onthe fund go towards asset management andadministration costs.

To begin with, different services in the value chain of delivery employ different charging structures.1

How these different charging structures compound over the 40-year period a member is exposed to their retirement fund, is animportant consideration in understanding which types of charges have the biggest impact on reducing value to members over that timeframe.

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By decomposing which decisions have the greatest impact on member outcomes, trustees can begin to have more meaningful debates onwhere costs could be contained without compromising those outcomes to members. More importantly, perhaps it’s time trustees rethinkwhere they should be more actively interested in what they are paying for.

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Distribution of charges allocated to a segregated fund for an average 35-year-old fund memberA crude assessment of how these costs are distributed over the spread of service provided

However if we were to assess how the power of compounding would affect those allocations over the 30-year period these members would haveuntil retirement, the allocation to asset management nearly doubles to 82.4% of total costs by the time the member retires. This translates into aweighted average of 66% for the whole period.

The effect of compounding on fee allocations over a 30-year periodThis is primarily a function of the compounding effect of each of the charging types employed across the value chain.

1. Getting to the problem of the cost problemThe issue of costs is multi-dimensional:

This outcome is a function of the different ways these services are charged, effectively we have three different charging models:

The asset managers apply an assets under management (AUM) fee model This model represents an annual fee charged as a percentage oftotal assets under management, inclusive of whatever growth occurred each year. Most commonly, asset managers charge these fees.Because all the assets are charged year a�er year, the compounding effect over time has its impact. For example, over a 40-year period, acharge of 0.50% on assets under management would compound to a 7.7% drag on a member’s replacement ratio.

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Consultants in this example charge a fixed service fee or retainer fee This fee is charged annually but is fixed based on specific servicesrendered with no reference to size of assets or frequency of cash flows. Of the three, this fee tends to have the lowest long-term impact onthe ultimate value to the member. Historically, actuaries and asset consultants have used this charging structure. Occasionally, though,asset consultants and implementation or fiduciary managers apply an AUM based fee.

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The administration fee is based on new cash flows to the fund The charge in this case applies only to the amount of new cash flows to thefund, when they occur (typically monthly). Some administrators use a fixed rand amount, others base it on a percentage of a member’ssalary, while others use a percentage of the member’s contribution. As such, the impact of these charges is significantly smaller over time.For example, for a new 25-year-old member contributing 15% and being charged a 0.50% of payroll fee on each of those new cash flows,there would typically be a 2.2% drag on the member’s replacement ratio a�er 40 years of contributions.

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The outcome of the fee impact is a function of the differentcharging structures and the way they compound over time.

Does paying a premium for fund manager skill pay off?Ironically, we o�en hear trustees argue that they have no problem paying a premium to fund managers if it means securing the top talent. Buthere is where we need to be completely clear about how this aspect of the value chain performs over time.

Consider the reality of most long-term investment strategies for defined contribution funds.

1. Identifying top-performing managersEven if we could be fairly certain that we have selected a skilful manager, there is absolutely no assurance that the market will reward thatmanager’s particular skill set going forward.

Chopping and changing managers in an effort to maintain exposure to top performing managers has been shown as a primary source ofvalue destruction in study a�er study of long-term fund performance.

As such, very few funds employ a single manager because of this single manager risk.

2. The impact of manager diversificationThe problem is, once multiple managers are employed, the impact of this diversification significantly reduces any short-term performance .

For example, individual managers may reflect tracking errors of up to 7% to their benchmarks, but the tracking error of the blended managerstypically reduces to around 2%. This is not a bad thing – such a diversification strategy provides a significant improvement on the fund’s risk toreturn ratio. But the total return of the blend will be muted.

3. The problem with performance feesEven assuming that manager fees are based on realised performance and not past performance, a fund could end up paying a high performancefee for a particular unspectacular outcome at the aggregate level. Performance fees are hugely problematic with multiple managers.

4. The impact of time on manager performanceIn reality, fund manager performance tends to go in swings and roundabouts over time. The longer the time frame, the more likely anyexceptional manager performance simply evaporates due to the impact of diversification of managers and the flux and flow of manager returns.

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Over the long term, performance outcomes are driven more by thelong-term strategic asset allocation embedded in the investmentstrategy than they are by individual manager contributions.

How much of a problem is this?As an example we consider the full value chain of costs in one particular umbrella fund to test the effect of an active against a lower-cost passiveinvestment strategy to the final member outcomes. We use identical member profiles and pricing structures. We also assume that the cost of theactive strategy would be 0.85% of assets under management per annum against 0.35% for our passive strategy.

By calculating the reduction in yield, a methodology that allows us to see the value erosion caused by the fee structure over a 40-year period, wecan see that a switch to a passive solution would equate to an additional 5.63% points to the member’s replacement ratio. While everyadditional point in the final replacement ratio is important, keep this number in mind for later when we look at other sources of value erosion.

Note that this analysis says nothing about performance differentials between the two strategies. But assuming that both strategies employ thesame long-term strategic asset allocation strategy, for the active strategy to even match the outcome of the passive strategy, it would have togenerate a consistent alpha of 50 basis points year a�er year for 40 years to compensate for the additional costs. Trustees would need to giveserious consideration to whether this is realistic.

Should this even be an active against passive debate?

2. Introducing a whole new modelCould a new model for asset management provide an answer?We would like to be provocative here. The government provides a tax incentive for an individual to save for their retirement using pension andprovident funds, preservation funds and retirement annuities in compulsory investing. We believe that for the world of compulsory investing tobe viable, the issues of performance chasing and performance fees (or high fees) must be taken off the table.

Perhaps it’s time we made a clear-cut separation in asset management servicing between investing to win the top performance sweepstakesand investing to meet a member’s replacement ratio requirement.

It could be done – and done in a way that could create a far more robust and diversified asset management industry in general. Imagine aninvestment world where active managers would provide two types of asset management services:

Mandates for compulsory savings vehicles Mandates for discretionary funds.

It’s time we made a clearcut separation in asset managementservicing between investing to win the top performancesweepstakes and investing to meet a member’s replacement ratiorequirement.

Mandates for compulsory savings vehiclesThe first mandate would be for the exclusive use of compulsory investment funds. The fee here would be capped at a reasonably low level,possibly halfway between what is currently charged for active and passive strategies for all retirement fund clients. The investment strategy onoffer would be whatever the manager felt was feasible at that fee.

But the irony here is that these mandates for compulsory retirement vehicles would be won or lost, not on performance, but on the manager’sability to follow a targeted, risk-budgeted mandate. This quality of delivery is essential in a blended manager strategy, because it gives themanager of the blend the confidence that their managers will remain diversified. Managers would lose mandates if they couldn’t control theirrisk budgets.

When compared to purely passive strategies, this blended strategy of risk-controlled mandates, if robustly diversified, should provideincrementally better risk-adjusted returns over the long term than a purely passive strategy – and not necessarily because managers are hugelyskilful. It’s actually the combination of the diversified mandates at a lower risk than the index that produces the magic.

The graphs on the next page illustrate this point, employing a real blended manager solution. The first graph shows the variable, rolling one-yearperformance of the different active managers in the blend over time. In the bottom graph the orange bars represent the aggregateoutperformance of the blend of managers.

In 2000, Allan Gray provided exactly this type of portfolio to multi-managers. It was a risk-controlled version of their Classic Equity portfolio,offered at a significantly lower fee. While Classic may have outperformed in certain market phases, this risk-controlled solution offered morerobustness over time.

Value of diversificationUncorrelated performance of the underlying managers

Source: Advantage Asset Managers

Value of diversificationReflecting a rolling 1–year alpha generation of the blend

Source: Advantage Asset Managers

Why two different mandates?The other mandate active managers could offer would be exclusively for discretionary clients. This would be the same value proposition they arecurrently offering. But asset managers would be welcome to charge what they view as fair for their alpha generation potential.

Why preclude compulsory savings funds from using the latter mandate? What retirement investments need is more certainty of outcomes if theyare going to meet the liability funding requirements over a 40-year investment period. The reality is that research repeatedly highlights thatshort-termism, and chasing return, has introduced one of the most important sources of potential value erosion in the active managementspace. For example, a study by Ron Bird and Jack Gray on the Australian Superannuation Fund industry calculates that these two factorsperpetuated as much as 3% of value erosion per year.

Right now the balance of power is on the side of asset management marketing machines that continually hold out a promise of more return.Retirement funds don’t need more; they need consistency, certainty and simplicity – and of course, lower costs.

A proposal like this creates opportunities that are not only fair toall parties, but could develop a far more diversified industry.

The value-add to the whole industryWhile momentum is gathering to promote passive over active strategies in this space, we believe a proposal like this creates opportunities thatare not only fair to all parties but would also develop a far more diversified industry. Consider the implications that such a model of separatemandates would have for asset managers – to say nothing of investors themselves:

Because the necessity for aggressive alpha generation would be taken off the table, active manager fee demands would readily fall.  Because outperformance would no longer be the primary criteria, the asset management industry could easily accommodate newer,

greener, less well-known asset management brands, as long as there were adequate risk controls. BEE managers could flourish in this environment and a few large players on both the active and passive side are far less likely to

monopolise ‘the pot’. Active management, which seems to provide a better risk-adjusted return to index funds as long as costs are kept low, could still be

considered a viable option for long-term retirement funds. Great alpha generators could still flourish and charge whatever the market will bear – but for a different market than a retirement savings

plan. It would also mean that current performance reporting would need to be completely revamped. The target would be the liability, or the

income replacement required by the fund member, and not the peer group.

What really matters to member outcomesIn truth, we have dealt with only one part of the issue of the cost relative to value discussion – and while the fees that service providers chargehave received the most attention to date, we need to understand other factors to address where value is destroyed for members.

In 2012, retirees from our universe of funds retired on average with a replacement ratio of 32% (a�er an average 21.7 years of pensionableservice) . And this was over a time frame when markets were generally flourishing. For the last 15 years the average active balanced managerhas generated around 10% real return – an impressive result.

If we look at only a subset of retirees, for those who have been in the same fund for 30 years or more (and therefore have reasonable savingsperiods without interruption), the average realised replacement ratio is actually significantly higher, as would be expected. This shows thatreasonable outcomes have at least been achievable from the investments – inclusive of current costs – given this favourable environment. Sowhere are things going wrong?

These numbers suggest that we need to examine the issue of cost from a different perspective. Instead of assessing what the service providerprovides (and whether they deserve its associated fees), we should turn the analysis on its head by asking: Which decisions have the greatestimpact on what ends up in members’ pockets when they retire?

A careful analysis of the sources of value erosion, when measured at member level, suggests that even if the investment strategy was capable ofdelivering a 75% replacement ratio (a�er reducing it 5.63 points for cost), the combination of inadequate preservation and a lower pensionablepay percentage proved to be significantly greater value destroyers.

Given that the government has not yet made retirement funds compulsory for all employees, nor has it firmed up its position on preservation orpensionable pay allowances, this leaves a significant burden on employers, trustees and consultants to try to manage these shortfalls.

Clearly to stem this value erosion, we need a more effective consulting framework.

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What affects member outcomes most? Whether the member preserves1Whether the contributions are a meaningful proportion of their salary (and is not reduced by pensionable pay choice) 2When contributions start3The allocation of contributions between risk benefits vs retirement savings4Costs5

Long-term asset allocation strategy6The additional value from fund managers above the long-term asset allocation strategy (alpha)7

Ranking the value-add of service providers

An important question emerges: If these factors are at the heart of the value erosion to members (and not poor performance or potentially costsof fund managers), then who should be accountable for getting it right? From a legal perspective, that answer, of course, is the board of trusteesor the management committee. But then who, in turn, is providing this incredibly broad aggregating function to the fiduciaries?

Compare a board of directors of a publically listed company to a board of trustees of a retirement fund. The critical difference is that corporatestypically have an executive management team that reports to the directors who are accountable for the day-to-day activities of the company.They provide the reality check on what is achievable, what isn’t, and what needs to be done to fulfil the board’s wishes. They bring technicaldepth and insight about the business to the table and can even be dismissed for not delivering the goods.

A board of trustees is presented with a different challenge. With the exception of a handful of parastatal and large corporate funds, mostretirement fund boards have no accountable executive that possesses a depth of technical insight and perspective on all the complex movingparts of delivery to members. While the new industry organisation, Batseta, is promoting the professionalisation of the principal officer role as away of filling that gap, few boards have the tools and resources that can provide them with a holistic picture on where they are winning or losingin this delivery.

This, in turn, means that boards of trustees are hugely dependent on their service providers – and not always in the healthiest way. The problemis, the way our industry is structured or ‘fragmented’, the most powerful entity in the value chain, from a compensation point of view, is the assetmanager, but providing that critical linkage is clearly not their role.

If the true source of value erosion is not with fund managers, thenwho should be accountable for getting it right?

Introducing the über-consultantThe truth is, if we are going to get this right for members, we need to define a completely new role that integrates all these aspects of delivery.

1. This suggests that to get these decisions right, what trustees and management committee members really need is a sort-of über-consultantwho can:

2. Create the critical link between the employer (and their HR departments) and the fund’s fiduciaries to eliminate any policy gaps.. Provide therelevant analysis of the membership demographics and behaviours to establish:

Member needs Suitable targets Suitable default solutions and A suitable asset allocation and investment solution to meet member liabilities

3. Define and manage an appropriate risk budget for the fund’s investment strategy.4. Consider appropriate platform and cost structures to address member profiles.5. Monitor member progress against established goals.6. Measure and monitor the potential impact of trustee decisions on specific member outcomes.7. Ensure appropriate communications of all these points to all relevant stakeholders.

The problem is that providing this type of service requires significant resources: member monitoring tools, asset-liability modelling tools, riskbudgeting tools, aggregated reporting and attributions analysis for funds, tools and models for member projections and for building asset classreturn assumptions. None of these tools are typically found in an asset manager’s range of capabilities, which begs the question once again:Who pays for this capability?

Essentially, we have a vicious circle here. Trustees may be right to question the value that consultants add if consultants don’t have thenecessary technology or the opportunity to provide the holistic picture that trustees so desperately need. But not paying for a service that hasthe greatest potential impact on outcomes perpetuates the problem because consultants see no way to cover the cost of being properlyresourced.

The reality is that globally, boards of trustees appear to be either turning their backs on asset and employee benefits consultants or pushingdown fees to unsustainable levels – probably with cause. Ultimately, the way these services are segregated in many consulting operationsmeans there is simply no way the holistic picture, which seems so eminently sensible, can realistically be delivered.

Two factors exacerbate this outcome:

Clearly it’s time for a new model of accountability and governance!

Owing to the different levels of specialist skills required, we now have a highly fragmented consulting industry.1We also have a regulatory framework that encourages separation of servicing functions.2

The world as we know it.

more efficient and focused way of delivering end value to themember, we can create a much more equitable value chain.

So where do all these insights into costs and the value chain leadus?We believe that the retirement industry as a whole desperately needs to rethink its value proposition to members. The reality is that a member’sfund credit can only withstand so much reduction in yield as a result of costs over the 40 years a member needs to be invested or drawing on riskbenefits.

We would like to believe that by creating a solution that provides a more efficient and focused way of delivering end value to the member, wecan create a much more equitable value chain.

We recognise too that everyone who enters this debate is conflicted at some level, including the authors, and readers may therefore treat thisdebate with some circumspect. That consideration is encouraged, but it should not preclude the debate.

Trustees need to rethink how to fairly allocate that maximum cost to ensure that both critical points – the liability management and the assetmanagement – are properly serviced and adequately resourced to get the job done comprehensively. We also need to recognise that only byinsisting that these two skill sets become more effectively integrated will funds be able to get greater certainty that they will get the outcomesthey require.

Combined, the über-consultant or über-asset manager concept provides a powerfully appealing way of addressing our problems of deliveringtargeted outcomes at controlled prices. In total, we should be able to reduce costs. While asset manager fees would most definitely come down,we should also be able to compensate investors with better risk-adjusted returns that are meaningfully sustainable in a long-term investmentstrategy.

On the consulting or actuarial side we’ve streamlined and focused the service to deliver measurable outcomes. A service this comprehensiveand with this much greater potential for delivering necessary outcomes, given the current environment of reform, now warrants a more seriouscompensation consideration.

3. How do we know if costs are suitable to a specific memberpopulation?Lowest cost is not always the best deal for the member, when we consider value. Likewise, lowest average cost is not always the best deal for theindividual member. In our last solution, we suggested that the long-term reduction in yields outcomes for individual members could varysignificantly depending on that member profile, their income levels and their fund credit. To properly round out our assessments about coststructures, we need to understand:

What are the criteria for payment? Where is it getting paid from? Who stands to benefit most from the cost structure? 

The important point is that services are o�en priced with the end user in mind. As such, we need to consider which pricing structure works bestfor which market segment.

Let’s use umbrella fund pricing structures as an excellent case in point. Comparing one umbrella fund’s cost structure with another can be fairlycomplicated, but some insight into how providers determine their pricing structure helps in determining which fee structure truly offers valuefor money for members, given their particular demographic make-up.

We need to consider which pricing structures work best for whichmember profiles.

We would like to believe that by creating a solution that provides a

also charge additional administration-related fees such as participating employer fees, investment administration fees or asset-based fees,resulting in two or three different administration related fees being charged.

2. Consider all fees when making comparisonsWhen comparing umbrella funds, consider the total cost per member across all the different fees (administration, governance, consulting andinvestments) and not only the administration fee.

National Treasury  has commented that “employers may be easily persuaded by low up-front charges (that is, those deductible fromcontributions) to select a commercial umbrella fund that in fact, because of higher recurring charges [in other words, high investment fees],represents lower ‘value-for-money’ than other commercial umbrella funds”.

This point is best illustrated through an example.

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Case studyJoe’s manufacturingJoe’s Manufacturing Ltd is a small manufacturing firm with 100 employees. These employees have a combined monthly pensionable salary of R1million and total retirement fund savings of R30 million. The company is looking to join an umbrella fund and is comparing various options.

There is a significant difference in the administration fees quoted by two of the options: Fund A will charge a monthly fee of 0.5% of themember’s monthly pensionable salary, whereas Fund B will charge only 0.25%. The investment fees of these two funds are fairly similar: 1.0%per annum of assets for Fund A against 1.1% per annum for Fund B. So which option should Joe Manufacturing Ltd select?

Our initial reaction is that Fund B offers significantly better value thanks to the lower administration fee. We pay little attention to the investmentfees as the difference between them is relatively small. However, if we calculate the combined rand administration and investment fee, we findthat this fee is the same for both funds (R30 000 per month).

Companies whose employees have managed to accumulate significant retirement fund savings need to be particularly aware of high investmentfees. If the member has a choice of investment portfolios with differing investment fees, they should not choose the investment option with thelowest fees, as that option would typically be a money market fund offering a lower expected investment return. Rather the member shouldassess the potential benefit of such a portfolio against its cost.

Total administration and investment fee

1. An umbrella fund's fee structure can be extremely complicatedThere are four broad categories of fees which a member in an umbrella fund will face: administration fees, governance fees, consulting fees or broker commission, and investment fees. These fees may be charged in a few different ways (initial or ongoing; fixed rand amount, percentage of salary, percentage of contribution, or percentage of assets). This makes it hard to compare apples with apples. For example, if Fund A charges a lower administration fee (as a percentage of salary) than Fund B, but a higher investment fee (as a percentage of assets), which fund is cheaper?And over what period?

Increasing the complexity is the fact that many umbrella funds charge multiple layers of fees. For example, instead of charging one administration and governance fee per member, some umbrella funds charge an additional scheme expense or contingency reserve account levy to cover governance-related expenses (such as audit fees, trustee expenses, FSB levies, and fidelity insurance premiums). These funds may

fund is selected.

The first employee, who has already saved a significant amount towards retirement, would prefer Fund A. This fund has higher up-front charges(charges that are calculated as a percentage of his monthly salary or contribution) and lower recurring charges (charges that are calculated as apercentage of his total assets). Fund A would result in this employee paying approximately R160 per month less in administration andinvestment fees combined (at the outset).

The second employee would prefer higher investment fees as his retirement savings account is relatively small. Fund B would result in thisemployee paying approximately R50 per month less in administration and investment fees.

Employee 1 has already saved a lot towards his retirement andshould prefer Fund A. This fund has higher up-front charges andlower recurring charges. Employee 2 would prefer higherinvestment fees and lower up-front fees as his retirement savingsaccount is relatively small.

Total administration and investment feeEmployee 1 (R3 million in savings)

3. Different charging approaches favour different groups of membersNote that there is not necessarily an optimal cost structure that suits all participants. The employer should balance the various trade-offs and select the cost structure most equitable to the majority of their employees. We can illustrate the point through two examples with Joe Manufacturing Ltd.

Example 1Administration fees are typically charged as a percentage of salary, whereas investment fees are charged as a percentage of assets. These different charging structures affect members with small and large retirement fund savings differently.

Two employees at Joe Manufacturing Ltd each earn R420 000 per annum. The first employee has worked for 30 years and saved R3 million in his retirement fund. The second employee has worked for 10 years and saved R420 000 in his retirement fund. Although the company is indifferent to the two options at the outset from the previous example (Fund A or Fund B), the two employees should have strong preferences on which

Fund A charges each member a monthly administration fee of 0.5% of their monthly pensionable salary. Fund C charges each member amonthly administration fee of R50. The total administration fee is the same for both umbrella funds (R5 000 per month) but the decision onwhich umbrella fund to select has significant implications to the individual members.

Total administration fee Fund C

Fund C charges all members the same administration fee (R50 per month), irrespective of the size of their salaries or their total contribution.Administration fees may be charged for collecting a member’s contribution and allocating it to their account, for example. Many of the expensesincurred in providing administration services have a fixed cost per member, irrespective of the size of that member’s contribution.

Therefore, charging a fixed rand amount is viewed as the most equitable approach from a financial or costing perspective. The issue with thisapproach is that the administration fee may become prohibitive for low-income members, significantly reducing the amount allocated towardstheir retirement savings and their expected replacement ratio outcomes.

If a factory worker at Joe Manufactoring Ltd earns R60 000 per annum, of which he contributes R500 per month to his retirement fund, he endsup paying 10% of his monthly contribution towards administration fees.

Total administration fee Fund A

Total administration and investment feeEmployee 2 (R420 000 in savings)

Example 2Different approaches to charging for the administration fee affect high-income and lowincome members differently.

Although this approach is more equitable, it introduces cross-subsidies between high-income and low-income members within that employergroup. Cross-subsidies need to be understood and managed over time.

4. Make comparison using prospective measures where possibleAll the examples make important points about how differential charging structures can affect members of a fund who may have different fundcredits, annual salaries, or years to retirement. While these types of comparisons are easy to calculate and understand, they only represent asnapshot in time.

When it comes to the long-term impact on the outcome to member, we need to be able to see how these charges compound over time. Thestarting point for most decision-makers is the graph below. This graph provides a composite picture of the total charges for each type ofumbrella fund pricing model. In this regard Fund X appears to be the cheapest. O�en the decisionmaker will stop at this point and simply selectthe cheapest option. 

Current monthly fees (company overview)

But the real test comes by moving beyond the limits of this snapshot. To add the dimension of time and how compounding impacts theoutcomes for various types of members, the chart on the next page provides the really critical information.

This measures the reduction in yield in the member’s annual return a�er the required period of saving. So, for example, although the ‘average’employee would appear to get the lowest reduction in fees from Fund X. In truth, though, for those members of the fund who either have a highfund credit or a high annual salary, Fund Y would have turned out to have the lowest impact on member out comes.

The key message here is that employers need to use more comprehensive measures in making their assessments of pricing differentialsbetween umbrella fund fees. A tool that can take one through the debates we have described above can fill that need.

Reduction in yield (10 years) – assessing impact on all members

Fund A’s charging structure is more equitable from a social perspective, as the administration fee would reduce all members’ contributions by the same percentage (assuming the contribution rate is the same).

The factory worker at Joe Manufactoring Ltd would pay an administration fee of R25 per month (0.5% of his monthly salary), reducing his retirement fund contributions by 5%. The CEO earning R1.2 million per year and contributing R10 000 per month to his retirement fund would pay a far larger administration fee (R500 per month or 5% of his monthly contributions).

Although costs are important, value needs to be the determining factor. Good value in an umbrella fund is all about ensuring that the fundparameters are appropriate, investment options are suitable and appropriately priced, the fund improves member engagement and financialeducation, and there is firm and fair governance structure to mitigate against catastrophic failures or conflicts of interest.

ConclusionCosts do matter. But paying the right amount for the value on offer also matters. It’s a delicate balance. But with the right tools and the rightunderstanding of the retirement fund value chain we should all be able to get to the right decisions about how to appropriately redress theimbalances that still exist in the market today.

The important point, though, is that it is the aggregate of all these costs that the member or investor actually bears. That means that thisaggregate cost has to be held up against the aggregate potential value that can be added – and this is where is gets complicated. Untilconsumers are in a powerful enough position to shake down the value chain and demand fees that are commensurate with the value that theservice contributes, the current cost hierarchy will remain.

There is only so much total cost a retirement fund or investment solution can shoulder and still provide investors with reasonable outcome. Thetravesty is that in a world that believes emphatically in the value of active management, trustees are more likely to try to force down the costs inthe other building blocks than take on the price-making top managers. But they do so at the risk of cutting back on the very services that aremost important in that final delivery.

References1 Bird & Grey (2009)2 Benefits Barometer 20133 National Treasury (2014)

VALUE EMPLOYEE BENEFITS COST ALLOCATION ASSET MANAGER COSTS OUTCOMES CONSULTANT

VALUE CHAIN PERFORMANCE ADMINISTRATION COSTS

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