James Louw, the head of implemented consulting at acsis, says investment governance has a crucial role to play if retirement funds are to meet the challenge of providing benefits for the growing number of retirees. Louw, a chartered accountant and graduate of Oxford University, was a speaker at a meeting of the acsis/Personal Finance Investors' Club in Johannesburg this week.
If the trustees of your retirement fund adhere to the principles of investment governance, they will be able to make the most of your fund's investments, James Louw says.
Corporate and investment governance has been around for decades, he says, but it has only come into focus in recent years. The main reasons for this are the ever-increasing deficits in corporate and state defined benefit pension funds, as well as the statutory requirement for trustees to be more vigilant about how the fund is governed, Louw says.
Stricter accounting standards worldwide have increased the disclosure requirements on companies and retirement funds, he says, resulting in assets and liabilities being recorded more accurately.
Before the new standards, the assets of companies and funds were overstated and liabilities were understated, and the financial statements did not provide an accurate reflection of the financial position of these companies and funds.
Liabilities in retirement funds have been rising because funds need more money to last longer, Louw says.
The number of retirees worldwide is set to grow significantly over the next few years, he says, and the elderly are spending considerably longer in retirement than people who retired in previous decades.
The rise in the proportion of elderly people worldwide will be the most defining demographic trend of this century, Louw says.
It is estimated that in 2006, the proportion of people over 60 will exceed those under the age of five for the first time in history.
The baby boomers (people born just after World War II) will be retiring between 2008 and 2020 and in China, the seven children that, on average, each Chinese parent had in the 1950s and 1960s will be retiring between approximately 2020 and 2040.
Compounding the need for retirement savings is the increase in life expectancy, he says. In the United Kingdom, the average lifespan in 1950 was 69.2 years. By 1995, the average life expectancy had jumped to 76.2 years, Louw says.
The number of centurions (people who have reached 100 years) has doubled every decade, he says, and by 2050 the number of centurions in the United States will be double the population of its capital, Washington.
Despite the growing need for retirement savings, Louw says, pension assets worldwide are dwindling. This is due to the changing nature of investments and corporate governance failures.
Changing nature of investments
Louw says that according to a study in the US, a shift took place between 1981 and 2001 in the way the 200 largest defined benefit pension funds invested their assets - namely, these funds significantly increased their exposure to equities.
One of the reasons for this shift is that women joined the US workforce en masse in the 1970s, and retirement funds sought to boost their savings by investing heavily in the equity markets, he says.
Another finding of the study was that the share of equities in US pension funds increased from 40 percent to 57 percent between 1981 and 2001, Louw says, while the share of bonds dropped from 38 percent to 31 percent and cash investments dropped by 10 percent. Overall, there was an 800 percent increase in pension funds' assets over this period due to bull markets and high fixed income yields.
Louw says because of the booming investment markets during the 1980s and 1990s, most of defined benefit funds experienced surpluses.
As a result, he says, many employers participating in defined benefit pension schemes took contribution holidays (in other words, they stopped paying contributions on behalf of members), relying on investment returns to fund their contributions.
But these surpluses turned into huge deficits during the three consecutive years of negative returns from the US equity market starting in 2000.
Global governance failures
The collapse of Enron and the failure of US Airways and United Airlines in the US led to huge losses within the pension funds of these organisations, Louw says.
He says South Africa has also had its share of retirement fund governance disasters. One example is the Joint Municipal Pension Fund, which lost over R1 billion after investing members' retirement savings in risky maize futures. Another example is the Transnet Second Defined Fund in which it was found that errors had been made in pension payments. Pensioners had been given a five percent increase in pensions instead of the scheduled two percent increase, over a period of two years.
Qualifications of trustees
Louw says some alarming facts about the qualifications of trustees of retirement funds emerged from a study by Paul Myners, who wrote a report on the failures of the UK's investment industry in 2001. The findings of the report include:
- 62 percent of trustees had no professional qualifications in finance or investments;
- 77 percent of trustees had no in-house professional to assist them manage members' money;
- 50 percent of trustees received less than three days' training on investments 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 spent less than three hours preparing for meetings on investment matters.
Louw says a report prepared by Deloitte this year found that, on the whole, there was insufficient investment governance in funds in South Africa. Some of the findings were:
- Many funds have no formal risk management policies;
- Trustees have insufficient knowledge about investments;
- 32 percent of trustees are unaware when the fund's investment policy should change;
- Only 16 percent of funds communicate the status of their investment policies to their members on a regular basis; and
- In most cases, the actuary of the fund also advises the fund on its investments. This creates the potential for a conflict of interest, because of the National Treasury's requirement that an actuary signs off the investment strategy, which should be developed by the fund's investment consultant.
Definition
Investment governance
is a component of corporate governance. It is the manner in which trustees make investment decisions within a framework that is compliant with their statutory and common law fiduciary duties.