Unpacking Default Regulation 37 – Default Investment Portfolio(s)

The default regulations, more specifically Regulation 37, require retirement funds to establish a default investment portfolio that is appropriate for the members of the fund.

All pension funds need to be compliant with the new Default Regulations, issued in terms of section 36 of the Pension Funds Act 1956, by 1 March 2019.

The main goal of the Default Regulations is to increase the value of members’ retirement savings through amongst others, lower charges and to ensure members retire comfortably.

There are three Default Regulations:

  • Regulation 37, which deals with default investment portfolios;
  • Regulation 38, which deals with default preservation and portability; and
  • Regulation 39, which deals with annuity strategy.

In this communication, we will unpack Regulation 37.

Default Investment portfolio(s)

The default regulations, more specifically Regulation 37, require retirement funds to establish a default investment portfolio that is appropriate for the members of the fund.

All retirement funds must ensure that the investment strategy that you (the member) are defaulted into would provide you with a reasonable income at the point of retirement.

There are various requirements pertaining to the default investment portfolio, and retirement funds are expected to comply with these requirements for your benefit.

As a member of a retirement fund, you are entitled to receive certain information from your retirement fund. This information should be communicated to you in a clear and understandable manner and on a regular basis.

The following information is an example of what your retirement fund should be disclosing to you.

  1. What is a default investment portfolio?

When joining a retirement fund, you will automatically be enrolled into the default investment portfolio.

If your retirement fund has made allowance for you to invest in various other investment portfolios (generally known as member choice), then you have the option to opt out of the default investment portfolio and invest your fund contributions – employee and employer in one or more of those member choice portfolios.

  1. Objective

The default investment portfolio is a strategy that is expected to be appropriate for you, as the member. This means that your retirement fund’s board of trustees must apply their minds in creating a default structure that will invest your fund contributions in a way that meets your needs and will assist in letting you retire with dignity.

  1. Asset allocation

The assets that you are invested in should be appropriate for your needs as a member. There are various asset classes that your default investment portfolio could invest in.

The traditional asset classes are:

  • Equities

Essentially, as an equity investor, you hold shares in companies that are expected to provide you with a high level of return (compared to bonds, for instance). Equities are relatively risky; however, this asset class is beneficial if you require growth on your investment which is in excess of inflation.

  • Bonds (similar to a loan)

Bonds are seen as less risky than equities. This asset class provides you with relatively more stable returns than equities but, over the long term, are expected to provide you with a return that is greater than cash but less than equities.

  • Property

Property investments are seen as relatively risky and able to provide you with capital growth over the long term.

  • Cash

Cash is similar to investing in a bank account. The risk is relatively small compared to other asset classes, which essentially means that the return that you expect from this asset class is lower than that of equities, bonds and property over the long term.

Your default investment portfolio is invested in a combination of these asset classes. The reason for this is diversification – not putting all your eggs in one basket.

For example, when the equity markets are down and you’re earning low or even negative returns, you could expect bonds or cash to still provide you with enough protection for your investment to not reduce as much as that of the equity market.

What is important is the combination of these asset classes that you’re investing in. The choice of combination will depend on your circumstances, such as age or what type of annuity (pension) you would like to purchase at the point of retirement. Therefore, these asset classes should be combined in a way that addresses your risk at any point in time.

As an example, for a younger member of a retirement fund, you could invest a greater percentage of your savings in growth assets (such as equities and property). As you near retirement, however, your needs will differ depending on your choice of an annuity (pension).

  1. Risk and Return

The default investment portfolio is expected to ensure that the risks and returns you receive are appropriate over the long term.

For a younger member this means a greater investment in growth assets which gives you a higher expected level of return for your risk profile.

For older members, however, the risks that you face may be different to your initial years in the retirement fund and are linked to the type of annuity (pension) you wish to purchase at retirement. Hence the default investment portfolio should be aligned to that annuity choice, for you to receive the required return and/or investment protection you require.

  1. Fees and Charges

Investment fees have a very big impact on the final income you will receive during retirement. A 0.5% difference in fee per year may not seem big for most members, but over the long term this could alter the lifestyle you can afford in retirement.

It is important to note that a higher fee does not necessarily mean that your return is less. For instance, if you expect a much higher return from equities than cash, it could be beneficial for you to invest in equities even though the fee is higher.

Over the long term, however, the return you receive would be much higher after all fees are deducted. Therefore, the returns you receive after all fees are paid are more important.

Your retirement fund should ensure that the fees you are paying for your default investment portfolio are reasonable and competitive.

Here is what you can do to IMPROVE your retirement outcome:

  • Start investing early
  • Stick to your long-term investment strategy
  • When changing jobs, don’t take your investment in cash, preserve it
  • If unsure, speak to a certified financial planner
  • Remember, your fund offers retirement benefits counselling that will assist you in making an informed decision about your retirement savings.