A lot of people complain that investment returns a few years down the line fail to match their expectations at the time they signed up for an investment policy, including a concerned Moneyweb reader who started investing in a retirement annuity (RA) 16 years ago.
“It looks like high fees absorbed most of my returns. The underlying funds performed better than [I expected], but when I look through my statements the fees are very high,” he says, adding that there is a large discrepancy between the performance figures quoted by the individual funds included in his RA and the returns shown by the investment manager.
In this case, the investment manager is Old Mutual.
The client, let’s call him Mr G for ease of reference and to keep his financial affairs confidential, asked Old Mutual for a full history of his investment after he noted in a recent statement that the value of his retirement savings seemed much lower than he anticipated.
He added up all his contributions and came to the conclusion that “after 16 years, Old Mutual has turned my R393 000 into R470 000”.
He also noted that he would have been much better off if he had put his money in a savings account over the years.
He’s upset that isn’t able to cancel the investment policy without attracting a big penalty.
“The joke is that if I want to withdraw my funds, they will penalise my funds by R50 000. So I would have made nothing towards my retirement in 16 years.
“If I placed my monthly debit orders into a normal savings account at any ordinary bank and received 7% interest rate on average, I would have been sitting with about R2 million today,” he says.
A look at the fund statements shows that Mr G is right on some points, but wrong in others in that he is not comparing like with like.
He is right to say that he has invested an amount of R393 000 over a period of 16 years, but that is not the same as investing R393 000 for a period of 16 years. The difference is huge.
Old Mutual says that Mr G started his investment in May 2005, investing R300 per month. The premium increased by 10% every year for roughly the first five years.
In December 2010, Mr G elected to effect a voluntary premium increase to R750 per month and in October 2011 increased the contribution to R2 000 per month. Thereafter, the premium continued to increase by 10% per annum on each policy anniversary.
In essence, only the first few instalments of R300 were invested for the 16 years to date and everything else for a much shorter period.
The bulk of his investment hasn’t had time to earn returns.
During the first six years of the investment plan, the total investment amounted to only R27 768. It was only this relatively small amount that benefitted from the longer investment period.
Old Mutual notes that the monthly premium on the policy is currently R5 187.34.
“Thus, in the last five years, although the premiums were higher relative to those paid in the first 11 years, they were invested for a shorter period of time,” says Marius Pretorius, head of marketing (retail savings and income) at Old Mutual.
“In addition, the growth would have been affected by adverse market conditions in the last five years,” says Pretorius.
One fund to blame
At around the same time that Mr G boosted his monthly contributions, he also made changes to the underlying funds in his RA.
He started with only one fund in 2005, the Nedgroup Investments Rainmaker Fund. Around 10 years ago, he added the Old Mutual RAF 40 Index Fund, Coronation Property Equity Fund, and the Allan Gray Equity Fund, splitting the monthly contribution between the funds.
Most funds did well, except for the property fund. The property sector on the JSE showed little growth between 2015 to 2020, and then the property fund in Mr G’s portfolio fell by around 50% when Covid-19 hit.
While most sectors recovered, the property sector did not.
Thus, close to 20% of the portfolio showed negative growth of around -4% per annum since Mr G diversified his portfolio.
“The poor performance of Coronation Property Equity Fund has negatively affected overall returns for this contract,” says Pretorius.
“The last four to five years have proved to be extremely challenging for most investment management companies in the equity market. Not only was market performance fairly flat from about April 2016 onwards, it was further exaggerated by the effects of Covid-19 on market performance.
“Three of the funds selected by the customer have experienced a recovery since March 2020. The Coronation Property Equity Fund, however, was the worst-affected of the four funds and has also been slower to recover, with an investment return over the past 9.5 years of -4.0% per annum,” says Pretorius.
Annual return on funds
(net of investment management fees)
|Fund||Total invested||Term||Actual investment return per annum||Return quoted by investment managers*|
|Nedgroup Investments Rainmaker Fund||R134 840||16 yrs||5.9%||6.4%|
|Old Mutual RAF 40 Index Fund||R72 657||10.4 yrs||7.5%||8.4%|
|Coronation Property Equity Fund||R69 477||9.6 yrs||-4.0%||4.2%|
|Allan Gray Equity Fund||R104 215||9.6 yrs||6.9%||9.6%|
|Total for RA||R381 189||5.2%||5.2%|
|* 10-year annual return per funds’ fact sheets|
Source: Old Mutual and individual funds
Quoting different returns
It irked Mr G that the performance figures quoted in the different funds’ latest fact sheets differ significantly from the returns quoted by Old Mutual on his portfolio. Even the property fund has grown by 4.2% per annum over the last 10 years, compared to the return of -4% according to his actual statements.
Both these figures are net of asset management fees, but the difference is that fund managers quote the annualised return on a lump sum investment 10 years ago rather than the returns on monthly contribution.
“The returns published in the fact sheets are at the fund level [fund price performance] over specified investment periods,” says Pretorius.
“This contract invests on a monthly basis, meaning that the returns are calculated on the growth applied to each monthly investment on a compounding basis. If the full amount had been invested 10 years ago, then the returns on the fund fact sheet could be used as a proxy to compare performance as the growth would then be compounded on the original amount invested over the period.”
Old Mutual reiterates that asset management fees as disclosed in the fact sheets, or disclosed when clients decide on a fund, are deducted from the pooled assets of the fund and the returns are therefore net of asset management fees.
However, advisor and administration fees are still payable from these “net” returns.
Mr G raises a point that many investors might agree with: “It took all my growth.”
Old Mutual explains that commission is paid by Old Mutual to the advisor and then recovered through a monthly charge deducted from the fund value. “In the first year and most recent year, commission of just over R2 000 was paid to the financial advisor.
“The commission has varied somewhat in other years due to the voluntary premium increases done in 2010 and 2011. On average, commission of R2 371.98 has been paid per year, which amounts to less than R200 per month,” says Pretorius.
Old Mutual disclosed that a total of R37 016.77 has been deducted from the policy in the form of monthly charges. The monthly charge of 1.87% per annum is disclosed in the contract, which has reduced over time to 1.3% nominal per annum as the fund value has increased.
This covers the cost of commission (0.7%), as well as ongoing administration and other initial expenses (0.6%). Included in the 0.6% is an administration charge of 0.35% nominal per annum that is levied by Old Mutual on the value invested in external unit trust funds, says Pretorius.
That is a lot of fees – some 9.4% of the total contribution to the RA went to fees, in addition to asset management fees already paid to fund managers of the underlying funds.
High penalty fee
Then there is a high penalty fee if Mr G decides to cancel his RA.
Old Mutual would charge a reduction fee when the contractual commitment is altered, such as if premiums are reduced or stopped, funds are withdrawn before the end of the premium payment term, or cancellation of the plan by making the plan paid-up before the end of the investment period.
This reduction fee recovers the future charges in respect of the initial expenses incurred on the plan that Old Mutual will no longer be able to recover.
Old Mutual uses a rather complicated formula to calculate the amount, which means that a charge of more than R49 000 will be levied against the portfolio.
“This equates to 10.58% of the fund value of R464 923.43. This is well within the current regulated Multiple Causal Event Charges Limit of 14%,” according to a letter sent Old Mutual sent to Mr G when he queried the matter.
If Mr G cancels now, he will effectively pay all the costs of the investment for the whole period.
The total costs for this investment, including all the commissions and administration fees, will exceed R86 000.
Better off in a savings account?
Mr G says he would have been better off investing in a savings account. “If I invested my money at 7%, I would have close to R2 million now,” he says.
His calculation is far off. He probably assumed that he invested the whole amount on day one of the 16 years. Even then, he would hit ‘only’ R1.1 million.
“Assuming the customer could invest his premiums at a rate of 7% per annum [after charges and tax], the investment would have grown to R559 777.70 by May 2021,” says Pretorius.
On the face of it, this would have been much better than the RA.
Unfortunately, the assumption of earning an average interest rate of 7% per annum on small amounts is probably way wrong.
The argument also ignores costs and the annual tax benefit of investing in a RA.
Interesting case study
The comment about a savings account versus a retirement annuity opens up a whole new debate.
The stock market usually wins over the long term when comparing interest rates with the annual return on market indices, or by comparing the growth of a lump sum in a bank account with the growth in the JSE Top 40.
What would have been the best for Mr G?
His figures put an excellent case study on the table, deserving more analysis.
Meanwhile, he should probably seek more advice from a financial advisor.