The time may be ripe for South Africa’s retirement savings industry to delve into Exchange Traded Funds (ETFs) given the expected industry shake up to come with regulatory changes, suggests Nerina Visser, Head of Beta Solutions at Nedbank Capital.
“If a key focus of the country’s retirement reforms is the achievement of risk adjusted, low volatility retirement savings growth at lower costs, ETFs undoubtedly offer an ideal solution,” says Visser.
“When one considers the significant erosion effect that even slightly higher costs can have on an individual’s retirement benefit over 20 or 30 years, the need for a transparent, affordable and reliable investment approach to form the cornerstone of the SA retirement industry becomes even more apparent.”
Visser says while the local retirement industry has lagged its international counterparts in adopting the use of ETFs as a means of achieving cost- and risk-managed retirement investment returns, Visser points to a number of recent developments that are likely to accelerate the introduction of these investment vehicles to numerous retirement funds.
The National Treasury’s recently issued white paper entitled ‘Strengthening retirement savings – An overview of proposals announced in the 2012 Budget’ demonstrates government’s commitment to implementing long-overdue retirement and savings reforms and identifies a number of specific issues requiring attention as part of those reforms.
Amongst the most prevalent issues identified is the need to significantly reduce retirement funding costs, standardise retirement products to increase cost competition in a way that benefits consumers, and place a greater focus on ensuring that trustees have the necessary understanding and ability to invest fund assets in the best interests of members.
The white paper also highlights the need for government and other retirement industry stakeholders to more carefully investigate the potential for greater use of passive or index-based investment management approaches in the retirement funding industry.
According to Visser the last suggestion regarding passive investment is arguably the most vital in terms of moving the reforms forward and has the potential to provide the SA government with all the solutions it needs to all the other seemingly complex reform issues it has identified.
Visser says that passive investment management, in particular the use of ETFs, offers trustees a significantly cheaper means of realising their investment duties without any lowering of long-term performance potential.
“The growing global popularity of ETFs amongst both institutional and retail investors is well documented,” says Visser. Given the longer than average investment horizon of the typical retirement fund, the ETF is increasingly being recognised as an excellent way to build value through market cycles and, ultimately, deliver the same or better performance as an actively managed portfolio, but at a fraction of the risk and cost.”
Visser says progress in the reform process, changes in the regulatory environment, and the increased investment costs associated with the entrenchment of look-through principles at both fund- and member level, as key to the wider acceptance of ETFs as preferred retirement funding vehicles going forward.
“Passive investments like ETFs provide heightened levels of transparency, liquidity, and cost control and offer the ability to target specified risk exposures,” she said. These benefits, combined with their usefulness in hedging or guaranteeing specific components of a portfolio make them an obvious choice to drive many of the proposed reforms concerning cost, risk management and fiduciary responsibility.”
Visser is quick to point out, however, that what she is proposing is not a passive versus active approach to retirement fund management, but rather a passive and active one.
“Both approaches have value to add in terms of meeting the unique challenges of liability-driven investing,” she said. So what is needed is really an alternative approach to the management of retirement fund assets that combines the best of all the approaches in a way that provides similar returns, on an after-cost basis, to traditional, active-only investment, but at a significantly lower risk.”
She calls this a ‘new paradigm in portfolio construction’ and describes it as a bottom-up approach that matches risk factors rather than asset classes and places a priority on performance-cost optimisation.
“The result of such an approach is the ability to build different solutions for different liability profiles” she says. Added Visser Nedbank Capital has already demonstrated its effectiveness through our range of BettaBeta Funds.
Visser says that, since inception, the Nedbank BettaBeta range of inflation targeted return funds has proven its ability to preserve the purchasing power of assets over time while targeting real returns over rolling three-year periods.
“These optimised, rules-based portfolios are fully complaint with Regulation 28 and 29 of the Pension Fund Act,’ she says, ‘and offer the type of cost effectiveness, transparency and predictability of performance that makes them ideal vehicles by which retirement funds can meet their investment objectives.”