Calculating the costs and efficiencies of your retirement fund

By Kobus Hanekom, Head: Strategy, Governance and Compliance

Calculating Retirement Costs

One of National Treasury’s key retirement reform objectives is to improve the disclosure of costs in retirement funds. This is a complex matter and it is very difficult if not impossible to express all costs in one number without a series of notes and explanations.

The reason why it is so difficult is that some costs, such as the administration and consulting fees of your fund are recovered on a monthly basis and are deducted from the contributions made to the fund. These costs are relatively easily identified and disclosed. Other costs such as the asset management fees are expressed as a percentage of assets and are deducted directly by the portfolio manager. Few members are aware of or are shown the actual amounts that are deducted. Even though these asset-based fees can be quite significant, members and employers tend to be more focussed on the administration fees and investment returns.

There is a move afoot to express all costs and charges as a percentage of assets. This is relatively easily done but because of the different relationships and scenarios you will not be able to tell whether the ratio is high or low unless you know whether it is a (young) fund with a low asset base or a (mature) fund with significant assets.   Because there are certain basic costs, the cost ratio for a smaller fund is also likely to be higher than for a larger fund.

We understand that to try and overcome these constraints an ASISA workgroup is developing a formula that will express the cost ratio over more than one term. This should make it easier to interpret the cost ratio.

Most importantly, such a formula will provide a fund / employer with a cost ratio for their fund that is directly comparable with the cost ratio of other offerings submitted in terms of a market review exercise. This will be a significant step forward for the industry and it enjoys our full support.

The ratio will assess the average cost effectiveness of an entire fund or a sub-fund in an umbrella fund. To be able to do so, the investment return, inflation and salary inflation projections of the cost ratio may have to be standardised. The information that will be required to do the calculation is: the Total Expense Ratio plus Transaction Costs (TER + TC) of the fund’s investment portfolio, all administration fees, consulting fees and the other operational costs (typically included in the contingency reserve levy).

Because the cost ratio will calculate a fund average, the ratio may not be very helpful in comparing and projecting the benefits of any individual member. It will also not be very helpful in determining the most appropriate default investment portfolio.

Determining a default investment portfolio                                 

If the draft default regulations are promulgated in their current form, each fund will have to implement a default investment portfolio that is appropriate for their members. To be able to make a selection will require each fund to consider all the relevant factors including the potential risks, returns and costs, with a view to providing the best retirement outcomes for its profile of members.

The most accurate way in which such a comparison can be made is to prepare a projected pension ratio or horsepower calculation in respect of each significant member profile in the fund to show how the projected returns and costs of the various portfolios will shape their retirement projections. The horsepower calculation will not only show the impact of the costs but also the return projections and the other features of each investment strategy or offering as required in the default regulations.

A whole new dynamic

If the cost comparison formula as well as the new default regulations are implemented, possibly as early as 2018, it will introduce a whole new dynamic – especially as far as this level of cost disclosure to members is concerned.

If the default regulations are implemented, funds who have already selected a default investment portfolio will have to do so again but this time in compliance with the new rules and principles. In doing so the fund would be wise to document their decision in a way that will stand up to scrutiny.

It appears desirable to run the horsepower calculation first, identify the most compelling default portfolio and consider strategies in which better economies of scale can be achieved, such as through portfolio consolidation, before the cost comparisons are done and communicated to members.

Disclaimer: This publication provides information and opinions of a general nature. It does not constitute advice and no part thereof should be relied upon without seeking appropriate professional advice.