To rectify a potential shortfall in a fund's retirement savings, James Louw says retirement funds can increase employer contributions, or cut back on future benefits to members or try to extract a better investment returns from the markets. There are problems with each of these options, Louw says.
An increase in employer contributions will come out of company profits, he says, and this will negatively affect the company's profitability and solvency. Cutting back on future benefits may also prove a costly exercise, Louw says. There were threats of mass strikes in the United Kingdom when it proposed increasing the retirement age.
Trustees often rely on improved market performance to remedy shortfalls in their funds, because they believe that "if the markets got them into the mess, then the markets will get them out again". But, Louw says, markets cannot be controlled, so trustees cannot rely solely on markets to address pension deficits.
Trustees should rather follow and apply sound principles of investment governance to the fund's investment process, he says.
It is crucial for trustees to be independent, he says. This means your trustees need to disclose any conflicts of interest and try to eliminate them, Louw says. Conflicts of interest can arise at board level when trustees accept gifts, trips and free tickets from companies that provide (or are trying to provide) services to the fund.
To address inadequate investment governance in retirement funds, Louw says the following systems must be put in place: an effective board of trustees; a written investment policy; appropriate roles and accountability of trustees and investment advisers, rigorous supervision and monitoring of investment decisions and of investment managers by trustees; and an effective flow of information to members.
Effective board
Louw says a board of trustees is effective if it:
- Draws up written guidelines and policies for making investment decisions;
- Engages in thorough debates before making investment decisions;
- Sets appropriate investment objectives;
- Implements an appropriate strategy to meet the fund's investment objectives;
- Draws up a plan on how to replace trustees with investment skills, should they leave the board;
- Understands what skills are required for sound investment governance;
- Has received proper initial and ongoing training in investments;
- Evaluates its effectiveness;
- Appoints investment experts to assist in matters where the trustees lack knowledge and experience;
- Consistently evaluates the performance of the investment consultants; and
- Appoints investment consultants who are independent of the fund's actuary.
A written plan
Louw says a written investment plan is necessary because it:
- Protects the retirement fund, the trustees and the members;
- Demonstrates that the trustees have adequately applied their minds to the investment process;
- Provides the proper framework and serves as a reference point for making investment decisions;
- Helps avoid "reinventing the wheel" when making investment decisions;
- Helps improve the quality of decision-making; and
- Delineates the responsibilities of trustees and service providers in the investment process.
Roles and accountability
For trustees to play an appropriate role and to be held accountable, Louw says, it is necessary for the board to:
- Document the roles and responsibilities in the investment decision-making process;
- Establish criteria for making important decisions, such as the appointment of a particular investment consultant;
- Establish appropriate communication between the management of the company and the board of trustees; and
- Set up an investment sub-committee that has the appropriate training and skills.
Supervision and monitoring
Rigorous supervision and monitoring of various tasks are required. The trustees need to:
- Identify risks and monitor the impact of investment decisions on these risks;
- Actively monitor and review the fund's investment strategy;
- Continually assess and review investment decisions and the investment advice received by the board;
- Exercise shareholder activism in companies in which the fund is invested; and
- Regularly monitor the asset allocation of the fund and the fund managers.
Effective information
Louw says the following is required if the information sent to trustees and members is to be effective:
- Trustees must receive information from the fund's investment consultant and asset managers to allow them to make informed decisions;
- The fund's investment managers must inform the trustees how they voted at the annual general meetings of the companies in which the fund is invested;
- The information received by trustees must be timeous, complete and accurate; and
- Trustees must inform members about the fund's investment strategy and how the fund is performing relative to its objectives.
What you should know
There is no legal requirement for trustees to develop the skills they need to carry out their investment duties.
But it is essential that the trustees of your fund and the fund's members have sufficient knowledge about:
- Retirement investment planning;
- Investment concepts; and
- Behavioural finance issues (in other words, the psychology of investing).
Furthermore, where funds offer individual investment choice, the trustees must educate and train members so that they can make the informed investment choices based on their needs.