Share

Beware retirement funds' hidden secret

(Shutterstock)
(Shutterstock)
WHILE retirement fund members may have different ages, incomes, fears and emotions, when it comes to retirement investing they all want the same thing - to maximise returns without taking unnecessary risks.

Investors encounter three major challenges when constructing optimal investment portfolios:

The knowledge gap - you are not necessarily skilled in how to invest, so the industry experts have an information edge over you.

The behaviour gap - even if you know what you should do, you are likely to be tempted to behave irrationally and emotionally.

Profit - the biggest challenge of all is the very fact that the industry that serves you wants to make a profit from you.

Fees eat at investor returns

The return on every investment portfolio is reduced by the fees paid. All else being equal, the more you pay in fees, the lower your returns.

Unfortunately the industry fee structures tend to be complex, high and opaque.

There are also conditional charges that are impossible to measure in advance, such as performance fees.

Treasury’s 80-page report on industry fees concludes that fees are high but impossible to calculate. That said, Treasury estimates average fees of 1% of assets for a large free-standing fund and up to 3% for retirement annuities (RAs).

Treasury shows that South Africa’s best priced RA is slightly cheaper than a large free standing fund, which is noteworthy.

How can a retail product with a minimum contribution of R1 000 per month be cheaper than a retirement fund with over R1bn in assets?

The answer lies is in how the product is designed, distributed and how much profit margin the provider seeks to make.

You may think that paying low fees leads to lower returns, but that is not true. The opposite in fact occurs: the best performing funds tend to have the lowest fees, while high cost funds tend to underperform.

If you invest R1 000 pm for 40 years, you would have invested almost R500 000 into your retirement fund. That is R12 000 per year multiplied by 40 years.

We should expect a real return of around 5% per year, so our R500 000 of contributions would grow to about R1.5m in today’s money.

But that’s before fees. A 1% fee is not actually 1%, it's 20% of your real return and it compounds to erode even more value.

Simply put, each 1% fee saving increases your final pension by around 30%.

Treasury said the following about fees:

A regular saver who reduces his retirement account charges from 2.5% of assets each year to 0.5% would receive a benefit 60% greater at retirement, all else being equal.

Alternatively, he could get the same benefit by making contributions over his lifetime that are around 40% higher.

The impact of fees is truly astounding, and is the retirement fund industry’s best kept secret.

The real world of investing

In the 20 years to December 2012, the US equity market (the S&P 500) returned 6% pa above inflation.

However, the average US equity fund returned 4% pa, which is 2% or a third lower than the market. There are two reasons for this: the leakage fees and the failure of active managers.

The failure of the majority of active managers is another well-kept industry secret.

Active managers market their ability to outperform the market – they call this alpha.

So, here’s the question. How much alpha is there available to all investors in the market?  

The excess return in any market above the average return is zero. Active management is a zero sum game.

Yes, some funds would have beaten the All-share Index last year as they were overweight retail shares.

But for them to have bought retail shares, someone sold them. For every winner there is a loser. But this is before costs.

Active management is very expensive. You pay high investment management fees. You pay performance fees to those funds that outperform, but the funds that underperform don’t write you a cheque  to compensate for their under-performance.

So this is an unfair incentive and is a major weakness of a multi-manager strategy.

Active managers trade more often than index funds, so you incur higher trading costs and taxes. The higher these fees, the lower the investor returns.

 - Fin24

*Steven Nathan is the CEO of 10X Investments.


We live in a world where facts and fiction get blurred
Who we choose to trust can have a profound impact on our lives. Join thousands of devoted South Africans who look to News24 to bring them news they can trust every day. As we celebrate 25 years, become a News24 subscriber as we strive to keep you informed, inspired and empowered.
Join News24 today
heading
description
username
Show Comments ()
Rand - Dollar
18.88
+0.3%
Rand - Pound
23.85
+0.2%
Rand - Euro
20.37
+0.3%
Rand - Aus dollar
12.31
+0.3%
Rand - Yen
0.12
+0.3%
Platinum
908.05
0.0%
Palladium
1,014.94
0.0%
Gold
2,232.75
-0.0%
Silver
24.95
-0.1%
Brent Crude
87.00
+1.8%
Top 40
68,346
0.0%
All Share
74,536
0.0%
Resource 10
57,251
0.0%
Industrial 25
103,936
0.0%
Financial 15
16,502
0.0%
All JSE data delayed by at least 15 minutes Iress logo
Company Snapshot
Editorial feedback and complaints

Contact the public editor with feedback for our journalists, complaints, queries or suggestions about articles on News24.

LEARN MORE
Government tenders

Find public sector tender opportunities in South Africa here.

Government tenders
This portal provides access to information on all tenders made by all public sector organisations in all spheres of government.
Browse tenders