New regulations and complex investment choices are making it tougher than ever to be a trustee of a retirement fund. At a recent meeting of the ipac/Personal Finance Investors Club in Johannesburg, Robert Macdonald, the head of implemented consulting at ipacSA, advised trustees on how best to survive the brave new world of pension fund governance.
Retirement fund trustees are an endangered species. They are nearing extinction because the rules of the pension fund management game are changing, and those who play it are not receiving adequate training, Robert Macdonald says.
The new rules place more pressure on trustees, who can now be sued for decisions they make with retirement fund members' money.
But, despite the difficulties that trustees are experiencing, it is not inevitable that they will die out, Macdonald says. Trustees can survive if they learn to play a different game.
To play a new game, Macdonald says, trustees need to do the following:
1. Raise their level of expertise
A detailed review of institutional investment in the United Kingdom in 2001, known as the Myners Report, found that trustees had little experience, training or expertise.
A South African survey by Deloitte & Touche, although less detailed, indicated that likewise in South Africa, trustees receive little training or support, Macdonald says.
According to the Myners Report:
- 62 percent of trustees had no professional qualifications in finance or investment;
- 77 percent of trustees did not have in-house professionals to assist them;
- Less than 50 percent of trustees received less than three days' training when they became trustees;
- 44 percent of trustees had not attended any courses since their initial 12 months as trustees; and
- 49 percent of trustees spend less than three hours preparing for decisions about the fund's investments.
The Deloitte & Touche survey, Macdonald says, found that in South Africa, on average, 10 hours of formalised training is provided to a board of trustees as a whole per year.
The survey highlighted a low level of trustee knowledge and experience, and an inadequate understanding of governance requirements as two of three major hurdles to effective fund governance in South Africa. The third hurdle was a perceived lack of employer interest in fund matters.
The Deloitte & Touche researchers identified poor governance and a lack of investment-related expertise on the part of trustees, and their consequent reliance on advisers, as two major risks to retirement funds, on a par with the risk of poor investment performance and market volatility, Macdonald says.
The Myners Report suggested that boards of trustees raise their collective level of expertise, rather than require that each individual trustee becomes an investment expert.
2. Turn to experts when they do not have the knowledge
While trustees do need more training, Macdonald says, they should turn to experts when they do not have the skills to make a decision.
This was also one of the findings of the Myners Report, which recommended that trustees treat their role in managing their funds as they would if they were responsible for running a company. When a company needs to deal with something that does not fall within its field of expertise, it calls in outside help, Macdonald says. Boards of trustees should do likewise, he says.
Macdonald says that when a board of trustees delegates to an expert, that expert should be held accountable if anything goes wrong. There is a legal precedent that supports trustees holding advisers accountable, he says.
3. set the fund's investment objectives and strategy
Trustees are in the best position to establish a retirement fund's investment objectives, Macdonald says.
In terms of proposed revisions to regulation 28 of the Pension Funds Act, trustees will in future be required to establish investment objectives that are relevant to the needs of the fund's members. They will then be required to develop an investment strategy to meet those objectives, he says.
The draft revisions to regulation 28 refer specifically to trustees using investment experts if they do not have the expertise themselves to develop appropriate objectives and a strategy.
The Deloitte & Touche survey, Macdonald says, found that fewer than 60 percent of the funds it investigated had a formally documented investment strategy, and most trustees had adopted a semi-active or passive role in the strategy's development.
Trustees should not underestimate the importance of asset allocation when they develop an investment strategy, Macdonald says.
The Myners Report found that trustees devoted little time or expertise to asset allocation. "They typically pay considerably more to have securities portfolios actively managed than for asset allocation advice," the report said.
Macdonald says the current version of regulation 28 provides trustees with very little guidance on investment strategy. There is no focus on investment objectives, with much emphasis on asset allocation restrictions. For example, retirement funds may not invest more than 75 percent of their funds in equities.
This, he says, has resulted in a herd mentality, with many funds following similar asset allocation strategies, rather than considering what is appropriate for their fund.
4. Appoint appropriate asset managers
Once they have developed an investment strategy, trustees need to appoint an appropriate asset manager or managers to implement the strategy. The draft revisions to regulation 28 require trustees to appoint asset managers according to set criteria.
Once again, if the trustees do not have the expertise to appoint an asset manager, they need to appoint an investment expert/adviser with the necessary expertise to appoint the asset manager. Provided the trustees have applied their minds to the information given to them, it is the expert/adviser who becomes accountable if the investment decision turns out to be a bad one for the fund.
Unfortunately, Macdonald says, very often asset managers are chosen simply on their performance relative to their peers, rather than on their ability to implement the fund's strategy and achieve its objectives.
According to the Deloitte & Touche study, the past performance of an asset manager and its past relationship with trustees were the most influential factors in decisions about which asset manager to select.
Macdonald says that according to the draft revisions to regulation 28, trustees will have to appoint an actuary who can verify that the investment strategy should produce the required results and sign it off.
He says the actuary, the asset manager and the investment adviser should be independent of each other, and not employed by the same company, in order to avoid a conflict of interest. If an adviser is employed by the same company that provides asset management services, the adviser may be tempted to recommend an in-house manager rather than the most appropriate manager for the job. Similarly, it is important to have an independent actuary sign off the investment strategy.
5. Monitor and review the investment strategy
Trustees need to monitor the performance of the fund's investments and the progress towards achieving the fund's goals. However, trustees should also set realistic time horizons when they set the fund's investment strategy, and the performance of asset managers should be evaluated with these horizons in mind.
The Myners Report said trustees were "extremely vague" about the time horizons of their goals when contracting investment managers. Macdonald says the report also found that "there is surprisingly little assessment or measurement of the impact and effectiveness of investment consulting advice, either on asset allocation or manager selection".
In conclusion, Macdonald says, if trustees want to avoid being held accountable for the poor performance and decision-making in their funds, they need to evaluate the advice they are given and, if it has not been appropriate, they should hold the fund's advisers accountable.
New rules
Governments and corporations around the world are making new rules and passing greater responsibility for pension provision to individuals, Macdonald says.
Fund members should regard themselves as stakeholders in their funds and take responsibility for monitoring and policing the trustees of their funds.
As populations are ageing, because of increased life expectancy, and births are falling rates, governments' liabilities to state pensioners are growing.
To reduce their liabilities, governments have increased the minimum retirement age and the minimum number of years of service people need in order to qualify for a full pension.
When companies have quantified their liabilities for future pensions, they have found that they have massive funding shortfalls and have responded by shifting more of the responsibility for providing for their retirement to their employees. This is borne out by a widespread move by employers away from defined benefit to defined contribution pension funds. Employers have to pay a certain defined pension (usually based on your salary at retirement) to members of defined benefit funds, while members in defined contribution funds are only given the total of their contributions and those of their employers plus any growth in these.
However, individuals are not very good at saving for their retirement, Macdonald says. For example, in Britain there is a £27 billion gap between what people are saving for their retirement and what they will need to enjoy a comfortable retirement. One third of all Britons are not saving anything.
It is estimated that only six percent of South Africans retire financially independent, Macdonald says.