Your questions answered

WHAT IS THE BEST WAY TO ASSESS UNIT TRUST PERFORMANCE?

Investors are often told to evaluate unit trust funds on the basis of long-term performance. How many years are considered to be “long term”?

Also, what yardstick should one use when evaluating performance? Funds have their own benchmarks, but does that necessarily mean that a fund is performing well? Don’t asset managers choose benchmarks they know there is a fairly good chance they will meet? Comparing how a fund has performed relative to other funds in its sector doesn’t seem to be very helpful either, because when the market is doing well, all the funds tend to do well, and vice versa when the markets under-perform. Surely the only benchmark that investors should use is whether a fund out-performed inflation after all fees?

Arnold Hastings

Michael Dodd, an investment analyst at Old Mutual Multi-Managers, replies: It is important to distinguish between the performance objectives of an individual investor and the stated benchmark of a unit trust fund, because these can often be two different things. Although I agree that, in the case of both an individual investor and a unit trust fund, performance should be assessed after fees, because this is a more accurate reflection of performance than gross performance, I wouldn’t necessarily agree that inflation is the “only” appropriate benchmark for an individual investor.

The individual investor’s yardstick for comparison should be linked to his or her investment objective and investment term (time horizon). For example, if the investor is putting away money for retirement and has determined that he or she requires an annual return equal to the Consumer Price Index plus five percent, this is the performance objective against which the investor’s portfolio should be assessed. On the other hand, if the investor is putting money in a low-risk investment in order to preserve capital, a cash-related benchmark would be more appropriate.

Ultimately, the primary measure of success for an individual investor should be whether his or her portfolio has achieved its investment objective over the investor’s time horizon. This measure of success can be extended to assessing fund managers and the unit trusts they manage: has the manager achieved its stated investment objective over the time horizon that it set for itself? This is the primary objective of a unit trust fund and is an important question to ask when assessing a manager. The stated investment objective often takes the form of the fund’s benchmark.

The CFA Institute refers to the acronym “Samurai” in determining whether the chosen benchmark is valid. In accordance with this, a benchmark should be:

* Specified in advance (known at the start of the investment period);

* Appropriate (consistent with the asset class being invested in or the manager’s style of investing);

* Measurable (the benchmark return can be calculated on an ongoing basis);

* Unambiguous (the benchmark is clearly defined);

* Reflective of current investment opinions (the contents of the benchmark are known);

* Accountable (the benchmark is accepted by the manager); and

* Investable (it is possible to invest directly into the benchmark).

Ideally, a fund’s benchmark would be chosen along these guidelines. However, many funds have benchmarks that do not fulfil all of these criteria.

In terms of what constitutes an appropriate period over which investors can evaluate performance, that very much depends on the asset class and the nature of the funds being invested in. Fixed-income funds, for instance, tend be more short term in nature and can be reasonably assessed over shorter time periods than would be appropriate for an equity fund, for example. Multi-asset funds and equity funds often require a longer-term mindset, because volatile market movements have a significantly more pronounced impact on the return profiles of these types of funds. In our estimation, the minimum period over which you can assess these types of funds is five years.

When selecting managers, Old Mutual Multi-Managers aims to identify managers that have an investment process that has delivered a proven track record over multiple time periods. It is highly unlikely that we would appoint an asset manager that does not have at least a three-year track record.

Finally, on peer comparisons: as I mentioned earlier, assessing whether a manager has delivered on its stated investment objective over its stated time horizon should be the primary measure of success. However, managers do not operate in a vacuum, and investors will be cognisant that there are many alternatives that could meet their investment objectives. It is worth remembering, however, that peer comparisons are relative in nature rather than absolute. It is reasonable to expect that, if equity markets are up 20 percent, for example, funds in an equity category will have delivered similar returns.

Peer comparisons are useful, but they come with a number of caveats. First, it is important to ensure that an “apples with apples” comparison is being made. This can be quite tricky, because funds in the same category may have completely different mandates. This highlights the importance of understanding what exactly it is that a fund manager is able to do within its investment portfolios.

Also, it is important to ensure that peer comparisons are made over an appropriate time period. Studies have shown that selecting managers based on one-year performance alone often ends up being a fool’s errand. In our opinion, a longer-term mindset is required when selecting fund managers.

MUST MY PENSION BE TAKEN OUT FOR LIFE?

I am 63 years old. My former employer forced me to take early retirement in February 2015 after it went into liquidation. I have been unemployed for the past year. I am now compelled to withdraw from the Alexander Forbes umbrella retirement fund and buy a pension. The pensions I have been quoted are impossible to live on: R2 200 a month after the one-third lump-sum withdrawal. Does the legislation permit the pension to be calculated over a shorter period – say, 10 years – and not for life?

I have not taken a lump-sum withdrawal previously. Can I withdraw the maximum tax-free amount of R500 000 (my fund credit is R700 000)?

Name withheld on request

Rory Shea, a financial planner at Old Mutual Private Wealth Management, replies: If you did not receive any lump sums on retirement on or after October 1, 2007, did not take a lump sum on withdrawal before retirement on or after March 1, 2009, and did not receive a severance benefit on or after March 1, 2011, you can take the full one-third of your benefit (R233 333), not the maximum tax-free amount of R500 000, as a lump sum and not pay any tax on it.

However, if you received a retrenchment (severance) package from your previous employer, it could affect the tax payable on your one-third lump-sum withdrawal and possibly reduce the amount you can take tax-free. Remember, the total tax-free amount from both retirement fund lump sums and severance benefits is capped at R500 000.

The next R200 000 you withdraw as a lump sum will be taxed at 18 percent, the following R350 000 at 27 percent and the balance at 36 percent.

You cannot buy an annuity for a shorter period; it must be for life.

You could consider the following options to increase the annuity income: reduce the guaranteed term of the annuity; buy a single life annuity (instead of a joint-and-suvivorship annuity); reduce the annual escalation to, for example, four percent instead of inflation; take out the annuity after your 64th birthday (annuity rates are linked to your age); withdraw less than one-third of your savings as a lump sum; or wait for interest rates to increase. However, these options might have a negative impact and should first be discussed with a financial adviser.

You could also invest some of the one-third lump sum in a discretionary investment that would generate an income to supplement your annuity.

Another option is to invest your retirement capital in a living annuity, where you can draw down between 2.5 and 17.5 percent of the capital each year. However, if the credit in your umbrella retirement fund is the only provision you have made for retirement, I would be very hesitant about recommending a living annuity, because you take the risk that the underlying investments will not be able to generate an income for the rest of your life.

Note: Letter writers will be sent the unabridged response thatPersonal Finance obtains on their behalf. However, published letters and responses will be edited for length and clarity.

Old Mutual Wealth provides integrated wealth planning and goal-based planning through financial planners, backed by global expertise and research. In order to create Old Mutual Wealth, Old Mutual has consolidated the expertise and resources of several established businesses: Acsis, Fairbairn Capital, SYmmETRY Multi-Manager, Old Mutual Unit Trusts, Old Mutual International, Celestis, as well as some investment consulting resources from Old Mutual Actuaries and Consultants. Strengthening Old Mutual Wealth’s position is the recent acquisition of Fairheads Trust Company.

Low-cost umbrella fund will ‘shake up industry’

Recently listed asset management company Sygnia, whose mantra is “low cost investment”, this week entered the umbrella retirement fund market. It bought Gallet Employee Benefits, which has an umbrella fund with 130 participating employers and 6 500 members, who have savings of R1.3 billion.

The umbrella fund will be renamed the Sygnia Umbrella Retirement Fund (Surf).

Magda Wierzycka, the chief executive of Sygnia, says many umbrella funds do not offer what they portray, with fees and costs hidden in multiple layers of charges, with total fees often well in excess of what an individual could pay by saving through a retirement annuity or a unit trust fund.

Umbrella funds commonly charge three tiers of fees: administration fees, consulting fees and asset management fees. There are many other fees, but these are typically well disguised, Wierzycka says.

The Surf will have one all-in cost equivalent to the average asset management fee. Administration and client servicing are essentially free of charge.

“Large umbrellas, which have dominated this market, have never passed the economies of scale on to consumers. We plan to change that. Our new product will shake up the industry,” Wierzycka says.

“Costs and investment performance are the two key factors to achieving a comfortable retirement. Based on our analysis, the choice of umbrella fund can make the difference between retiring with an income equivalent to 50 percent of your pre-retirement income or 100 percent of that income, based on a 35-year time horizon.”

The fund will also provide a seamless service between saving for retirement and drawing an income in retirement.

In saving for retirement, members will be offered a limited choice of investments and employers will be able to select from two default life-stage options that reduce investment risk in the last six years before retirement, essentially providing a reasonable match before retirement to strategies generally used in retirement.

In retirement, the default will be a pension structure provided by the fund that combines both an investment-linked living annuity, provided by Sygnia, and a with-profit annuity, provided by specialist pension company Just Retirement.

Members will also be allowed to retain their membership of the fund should they resign from their employment before retirement age.

Wierzycka says that Sygnia’s all-in fee, based on its asset management fee, is, at its highest level, 50 percent lower than what its large competitors charge. The fees on Sygnia products range between 0.399 and 0.855 percent on domestic assets and 1.14 percent on international assets on its actively managed Signature product range, and between 0.39 and 0.59 percent on its passively managed Skeleton product range, depending on the range option and the amount invested.

Underlying asset management fees are paid from the fees quoted, except where hedge funds are used, in which case the underlying management fees are deducted from the returns within the hedge fund.

Performance fees are paid on some underlying actively managed mandates, but only where performance exceeds agreed hurdle rates, and they are subject to maximums. Hedge funds and active managers with performance fees are included only where Sygnia believes this will add value and improve returns while reducing volatility.

If non-Sygnia investment portfolios are selected, the all-in fee will be between 1.14 and 1.4 percent.

Wierzycka says against this, most existing umbrella funds have “creative” charging structures – some of which are transparent, but some of which are opaque.

The way the fees are structured – with some a percentage of assets, and others a percentage of payroll or rand amounts – make it difficult for members to understand exactly how much their membership is costing them (see “Retirement fund costs”, below).

David Hufton, the head of Strategic Projects at Sygnia, says umbrella retirement funds are needlessly providing expensive services normally only necessary for stand-alone occupational funds, such as consulting services to the participating employers and their management committees. This places unnecessary demands on the management time of employers, which should, in fact, be reduced by participation in a well-governed umbrella fund. He says that some of these services could be discontinued with no downside for the members and replaced with standardised communication services.

Hufton says that high costs simply translate into less money in retirement.

“National Treasury, in its paper, ‘Charges in South African Retirement Funds’, calculated that if a regular saver reduces charges on retirement savings from 2.5 percent of assets each year to 0.5 percent, that person would receive a pension 60 percent higher after 40 years of saving.”

Hufton says that by charging a single fee, Sygnia’s umbrella fund will not only lower the cost of membership, but will also remove unnecessary complexity.

PHASED CONVERSION TO WITH-PROFIT ANNUITY

The Sygnia Umbrella Retirement Fund (Surf), is structured so that members can use the fund as a savings vehicle as well as one that provides a pension at retirement.

The fund will offer members a number of in-fund pension options, including a default option. The default pension will begin as a living annuity and gradually convert to a with-profit annuity over 10 years.

The living annuity is provided by Sygnia, and the with-profit annuity by annuity company Just Retirement, with the underlying investment in a fully passive Sygnia portfolio.

Simon Peile, the head of investments at Sygnia, says that the combination of the two allows you to take advantage of a better guaranteed pension as a result of getting older, and reduces the risks of the living annuity.

In structuring the combination product, Peile says the default options can be used to balance the two main demands of pensioners: that they receive a secure and sustainable income and that they can leave as a bequest to their heirs any money not required for a pension.

The risk of running out of money with a living annuity is removed by converting to a with-profit annuity.

And in delaying the conversion, you are assured that your heirs will, in the early years of your retirement when your capital is greatest, benefit if you die early.

Peile says that Sygnia decided to use with-profit annuities because it believes they offer a better outcome than a conventional guaranteed annuity. Among the reasons are:

* The underlying investments of conventional guaranteed annuities are mainly interest bearing. With-profit annuities have greater exposure to growth assets, such as equities, which provide better long-term returns.

* Investment returns are smoothed, keeping back some of the profits to pay better increases in years of poor investment performance.

Peile says the default option of converting to a guaranteed annuity can be put on hold if, for example, there have been very good returns on the living annuity, and you feel as a consequence that you are able to leave a greater bequest.

Pensioners not choosing the default can maintain the living annuity for a longer period. Sygnia will provide you with tools to assist you in making the trade-off between providing a sustainable income and providing a financial legacy for your heirs.

Peile points out that once you have transferred assets into the with-profit annuity, you cannot transfer them out again.

He says that the default option manages the percentage that is converted each year from the living annuity to the with-profit annuity, as well as the annual percentage drawdown from the living annuity.

“Over time, the drawdown rate from the living annuity component increases. The drawdown rate is calculated using the with-profit annuity rates. In this way we ensure that the pension remains sustainable, as long as the pensioner adheres to the default drawdown rates,” Peile says.

EXAMPLE

Based on a number of assumptions about investment returns and inflation, a pensioner who has retirement capital of R5 million will receive a monthly living annuity pension of R28 270 (6.78 percent drawdown) in the first year. In the second year, the living annuity pension will reduce to R26 970 (but with a drawdown rate of 7.07 percent) following a transfer of 10 percent of the capital to the with-profit annuity, which will provide a further R2 997, providing a total pension of R29 966 (a six percent increase on the previous year).

In the 10th year, the living annuity will provide R4 776 a month (drawdown rate of 11,41 percent) and the with-profit annuity R42 985 providing a total monthly income of R47 761.

Peile says that, over time, the pension, in aggregate, should keep pace with inflation.

RETIREMENT FUND COSTS

You could be paying a lot more than you realise as a member of an umbrella retirement fund, warns John Anderson, a portfolio manager at Sygnia Asset Management.

The fees include:

* Fund administration fee: a basic fee, which is a percentage of payroll or a rand amount, which ranges from about R20 to R155 per member per month.

* Risk benefit administration fee: normally a rand amount of about R7.50 per member per month.

* Risk management fee: for the administration and actuarial management deducted as a percentage (normally about five percent) of the risk benefit premium.

* Commission on risk benefits: these fees, which are regulated, are paid from risk benefit premiums and paid to an adviser or consultant appointed by the fund trustees.

* Employer participation fee: a rand amount of about R500 per employer per month deducted pro rata from members.

* Asset management fees and performance fees: a percentage of assets under management, with base fees ranging from 0.4 to 1.5 percent a year depending on asset managers selected. Performance fees are applied in certain instances above this.

* Assurance policy charge/levy: an additional annual fee of 0.05 percent of assets under management related to the policy within which the assets are held.

* Capital guarantee fee: a fee of up to 1.6 percent a year charged on smooth-bonus funds on top of asset management fees.

* Manager access fees: an annual fee of between 0.1 and 0.2 percent of assets under management for access to funds that are not in the stable of the retirement fund sponsor.

* Commission/advice fee: a rand amount of between R34 and R64 per member per month, on average, for the provision of advisory services to participating employers in the fund.

* Specialist investment consulting fee: this service, which is often compulsory and limited to in-house advisers, is provided to participating employers at a cost of up to 0.57 percent of assets a year.

* Switching fees: a rand amount of about R450 when a member switches from one investment portfolio to another. Normally, at least one free switch is permitted.

* Assorted levies: these may be paid as a rand amount or a percentage of assets and include fees for audit, actuarial and legal services, fidelity insurance premiums, independent trustee expenses, valuation fees and mandatory fees paid to the pension funds regulator, the Financial Services Board. These total between R1.50 and R3.50 per member per month.

* Ad hoc legislative changes, when legislation requires a change to the management of the umbrella fund.