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Who is picking your umbrella fund?

And are they thinking about all of the costs?

Since 2010 the amount of money held in corporate umbrella funds has grown by over 350%, from R66 billion to R263 billion. This is over a period in which the total assets of all corporate pensions has less than doubled.

Umbrella funds now account for 15% of the market, and that share is growing rapidly. In 2010, they made up just 6% of the total.

 capture-12_1

Source: FSB annual reports, NMG Consulting

“Since 2004 National Treasury has been punting the benefits of consolidation in the form of lower costs for the member and improved governance due to the economies of scale,” says Thabo Khojane, MD of Investec Asset Management. “Service providers have also taken the opportunity to promote their products successfully, to the extent that one of them, Old Mutual, has even shut down the alternative of standalone administration.”

This combination is what has led to many corporates moving from individual schemes into pooled umbrella funds. A recent study commissioned by Investec Asset Management and conducted by NMG Consulting has found that umbrella funds allow companies to “reduce their administrative burden, governance requirements and fiduciary responsibility all at a cheaper overall cost to company”.

Which fund?

What is important to understand, however, is how companies and trustees choose which umbrella fund to use. Very often, this decision is heavily influenced by an employee benefits consultant.

“Often, however, the employee benefit consultant is linked to an umbrella fund,” says Khojane. “So what’s happening at the moment according to the NMG report is that, in the large majority of cases, there is a strong correlation between the consultant and the umbrella fund where the trustees end up.”

In other words, these consultants are promoting their in-house umbrella funds. And the argument they put forward is almost always the cost.

“Trustees are looking for the most attractive cost proposition,” Khojane says, “but they are being guided by someone who is aligned to a particular provider.”

This creates two issues. The first is that the consultants may not always provide companies with a clear comparison of their options. The second, is that when they discuss cost effectiveness, they are talking only about what is the best deal for the employer, and not for the members. This creates a potential conflict between what is good for the company and what is good for the employees in the fund.

“Often it is the chief financial officer or financial director who makes the ultimate decision, and NMG’s finding is that when they look at cost they are not looking at it in terms of the complete cost, but specially the cost as expressed as a share of payroll,” says Khojane. “That is typically the cost borne by the employer or sponsor. But they do not go as far to look at what the members’ costs will be once they are inside the scheme.”

As the graph below illustrates, advice and administration costs are usually covered by the employer. This is paid as a percentage of monthly payroll. However, the bulk of the asset management fees are paid out of a member’s pension pot, and these can vary considerably depending on the solution used within the fund.

Illustrative split of employee benefits costs between company and employee

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Source: NMG Consulting

“It is imperative that the decision-makers selecting an umbrella fund start to consider the total cost of these services,” NMG argues, “not just the cost incurred by the company itself.”

A win-win

Khojane however believes that there is good news in this regard with the introduction of a new measure of cost called ‘Estimated Annual Cost’ or EAC. The Association for Savings and Investment South Africa (Asisa) has already rolled this out for linked investment service provider (lisp) platforms.

“What the EAC does is capture the complete cost to the investor,” Khojane explains. “That means the asset management fees, administration fees, advice fees, exit penalties, everything, and expresses this cost in a way that anybody can compare service providers.”

Asisa is now looking to ensure that the EAC is used across the savings and investment industry.

“I think that sometime during 2017 we will see it rolled out into the umbrella fund space, and when that happens it doesn’t matter that the employee benefits consultant is punting the in-house product because they will have to put the facts on the table,” Khojane says. “Employers will therefore have a lot more information to work with in making an assessment of how one umbrella fund compares to the next. My understanding is that at the moment it’s quite difficult because they don’t all talk in the same language or quote their costs in the same way. So as a financial director or trustee you are trying to figure out how these things compare. The EAC will eliminate that problem.”

The conversation will therefore naturally develop from what is the cost to the employer to also including a discussion around what are the costs to the member. And that should tackle the problem of any conflict between their interests.

“There is a misalignment at the moment, but the good news is that it’s easily resolved so that there isn’t a win-lose situation,” says Khojane. “I think you can have a win-win for both the employer and the employee.”

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Trustees frequently make decisions based on the lowest-cost umbrella fund provider. Although there are some arguments in favour of this, there’s also arguments against it.

If my company is the lowest cost provider, it simply means that I can’t pay my staff as much as other (higher cost) providers, and/or that my company offers reduced profits to investors. Shareholders typically won’t tolerate lower long term profits, which means there’s downward pressure on employee remuneration. If I pay my staff salaries less than market rates, the best staff will inevitable leave to higher-paying institutions, while my low-cost firm is stuck with those employees which can’t find jobs elsewhere. This eventually translates to worse service delivery than those firms employing the best staff, and therefore unhappy customers. I’ve spent 20 years in the retirement industry, and have seen this over and over again.

It’s the same thing with buying cars – if you only focus on costs, you will probably end up purchasing the newest low-cost product from India, while overlooking more tried-and-tested products from Germany. While both the products from India and Germany will get you from point A to point B, the experience you will have getting from point A to point B differs significantly between the products (albeit at a cost). You decide what works for you.

If cost is everything, why are some customers spending their food Rands at Woolworths instead of Checkers? With umbrella funds, as with most other things in life, buyer beware.

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