Monthly Archives: March 2017

The critical role of a consultant in umbrella funds

Sanlam Employee Benefit’s head of special projects David Gluckman penned the following in response to a recent article published as part of a Sygnia marketing campaign.

Consistency is the only currency that matters” is a well-known slogan of one of South Africa’s leading asset managers.

At the other end of the spectrum, a new player entered the commercial umbrella fund market less than 4 months ago proudly announcing “one all-in fee as a percentage of assets under management” and illustrating projected cost savings to clients adopting this model versus the competing leading commercial umbrella funds. Besides some fees such as costly hedge funds being over and above the so-called “one all-in fee”, importantly all these projections assumed there would be no need to separately pay for the services of a consultant. Today the message is slightly different and we should now understand that these projections were never accurate in that the true intention was always to leave “financial room for the employment of independent consultants.”

But the new player does raise some valid questions as regards the most appropriate governance model for commercial umbrella funds. These questions are important given the massive growth in this market (see graph below).

Two recent experiences highlighted to me that a very important question to explore is what will in the future be the role of the consultant in commercial umbrella funds.

  1. One highly respected independent consultant to a large book of Sanlam Umbrella Fund clients (and who also has many clients participating in other major commercial umbrella funds) raised the issue with me at our 2016 Sanlam Employee Benefits Benchmark Symposium, and said he is worried about the sustainability of his business given the increasing power of the major commercial umbrella fund sponsors.
  2. Various senior Financial Services Board officials also raised the matter in an April 2016 workshop with Sanlam Umbrella Fund representatives, essentially asking whether consultants introduce an extra and unnecessary layer of costs. They wanted to explore whether Sanlam could instead provide these advisory services thus savings costs for the ultimate clients of umbrella funds being the members.

The Sanlam Umbrella Fund governance model was structured consistently with thinking as set out in my paper entitled “Retirement Fund Reform for Dummies” presented to the Actuarial Society of South Africa as far back as 2009. In that paper I argued:

The role of intermediaries (aka consultants) requires particularly close scrutiny. I would argue their role is a particularly vital one if we want to create a culture of effective competition.

Rusconi argues “In the institutional space, however, savings levels are less likely to change and marketing is more about attracting another provider’s customer than about motivating additional savings”.

Such arguments emanate from the premise that intermediaries do not add value to consumers – an assertion that I would challenge. My view is that there are both good and bad intermediaries, and we need to find a model where market forces will push in the direction of forcing intermediaries to continually “up their game”.

There are many good intermediaries who not only fight for the rights of their clients, but also serve as an effective means to ensure that product providers are continually aware of the need to provide quality service in an increasingly competitive environment.

Easy way to increase your wealth

I am regularly asked for advice by younger people looking for a sure-fire way to build their wealth. They are often surprised when I tell them to invest more time and money in themselves and their human capital. Historically, people who do this are likely to create significantly more wealth over their lifetime than those who don’t. It is obvious that you need to accumulate investment assets but you also need to ensure that you earn income at an increasing rate over your career. The best way to do this is by investing in yourself.

What is human capital?

Human capital is the combination of skills, knowledge and abilities you have that will enable you to generate income over your working life. Nearly all of us have an ability to generate some income but very few people consistently invest in themselves so that they can increase their earning potential over time. According to the Federal Reserve of San Francisco, university graduates generate R16 million more income over their careers than non-graduates. This might give some context to the #feesmustfall campaign in South Africa.

If you choose to invest in yourself, you need to ensure that your skills and knowledge remain relevant and adaptable to changing economic conditions and an evolving business environment. You should regularly review whether you need to add to your skills or knowledge-base. Additionally, you need to be honest enough with yourself to be able to decide if you need to change careers if you are in a dead-end street. For instance, I would not consider newspaper printing as a long-term career option!

Specialise but not too much

Some careers reward those who specialise but one should always be careful of becoming too narrowly focused in your career. For example, deciding on an academic career researching the mating habits of albino penguins in the Southern Cape might not ensure a long-term income. However there might be less risk in being the orthopaedic surgeon who specialises in surgery of the shoulder in South Africa. Many young people strive to be a manager in a large corporate. This might be the most risky career choice one can make. Managers are essentially generalists and are often the first people to be fired in a merger or downsizing. If you plan to work in a corporate, you might do better focusing on being a revenue generator or product specialist.

Not only for academics

If you are not academically inclined or you have no interest in tech, you could always consider specialising in old world industries. There is a massive shortage of plumbers, electricians and general handymen. Now that more people work in services industries, there are many fewer people who can work with their hands. This provides an ideal opportunity for reskilling yourself if you have the inclination.

In the age of mass production and “mass specialisation” provided by the internet of things, it should not be surprising that there is a major shortage of people who can build or create objects with their hands. I believe craftsmen who can make handmade items such as furniture or master builders are in big demand. It does not surprise me that craft beer, artisanal baking and coffee are becoming major industries. More people are becoming interested in where their food and drinks are made and this includes where the ingredients are sourced. This is the type of trend that is likely to suit those with old world skills and when skills are limited and demand is increasing, your earning ability increases rapidly.

It does not matter what you do today, you need to be conscious of how you can grow yourself and possibly change course when required. Viewing yourself as an income generating asset that requires work and maintenance is probably your best investment. Charlie Munger said of his business partner: “Warren Buffett has become one hell of a lot better an investor since the day I met him, and so have I. If we had been frozen at any given stage, with the knowledge we had, the record would have been much worse than it is. So the game is to keep learning, and I don’t think people are going to keep learning who don’t like the learning process.”

Financial advice worth the cost

Q: I will be going on pension at the end of this year at the age of 65. I have no debt and my home is paid for.

I have been involved with four different financial advisors, but cannot get away from the exorbitant costs that are involved. I have my pension and a separate retirement annuity (RA) and about R2 million in cash which they all would love to invest for me. I am left with the impression that they could invest my money to earn about 1.5% per annum more than I could, but since their fees will be 1%, it hardly makes it worth my while.

I now seem to think that my best option is to take my R500 000 tax-free allowance from my pension and draw down the minimum of 2.5% on the rest. If I subsidise myself from my cash reserves, I can survive for the first six years of my retirement while still leaving the rest of my pension to grow. I would not even have touched my RA yet.

However I’m still wondering if I  would be better off investing the cash amount through a financial advisor?

To answer this question, we need to take a step back. Before you can decide what you want to do with your money, you need to know what you want to do with your retirement.

One person’s retirement dreams are very different from another’s. For some it is to slow down, but for others it is to do the things that your working life never allowed you to do.

At your age a financial plan should support your remaining life plan and lifestyle. Your  financial plan is one component of a flexible life plan that will need to see you through from your mid 60s into your late 90s.

Bear in mind that if you manage your investments yourself, you need to set aside the time to monitor your portfolio and be disciplined to adjust to different market conditions. You also have to keep your emotions in check when markets are volatile. These demands and complexities of successful investment management can prove challenging, even for the most informed individual investor.

People everywhere are also living longer. You therefore have to consider the long-term implications of managing risk, your money, tax and liquidity.

In addition, we live in very uncertain times. The IMF has cut South Africa’s 2016 growth forecast to 0.1%, foreign investment in the country has dipped to its lowest in ten years, a credit downgrade is still on the horizon, and there are still uncertainties around Brexit and Chinese growth, to name only a few. Getting the right financial advice to manage these risks is more important than ever.

A professional advisor will help you set up different investment strategies to achieve certain financial goals and provide assistance and guidance with retirement and estate planning. Competent financial advisors are knowledgeable about financial markets, investing landscapes and tax implications.

The reality of retirement

Q: I am 56 years old, healthy, have a reasonable job and presume I can work for the next 10 years.

I have a home which is worth about R2.5 million, with a relatively small bond. However, apart from an annuity worth about R300 000 I have no other savings.

My youngest child is almost independent, and in a couple of months time I will be able to save R10 000 per month. This amount can increase to R20 000 in the next 18 months.

How should I invest this money and how much trouble am I in?

The really important question here is the last one. In our view, any investor currently requires approximately R1 million for every R4 200 of monthly income they want before tax and after costs.

This yield is specifically constructed to provide an escalating income that keeps up with inflation. We are aware that an investor can source a fixed yield that is higher, but that would mean that it doesn’t increase in the future and progressively becomes worth less.

This also assumes that your capital will be maintained and over occasional periods will grow faster than inflation. This is important, because if you don’t have to use up your capital, how long you live and how long you need an income for become inconsequential. You could live beyond 100 and still have a secure income.

This is obviously the optimum position.

The next important question is then what to invest in to give you the best chance of building a retirement pot. The table below will demonstrate a value in today’s money of what your savings could be worth in ten years’ time. This is based on 18 months of investing R10 000 and then 102 months of putting aside R20 000 per month.

When looking at this table you have to consider that there are two key drivers that affect the investment return.

The first is cost. It may seem intuitive but it is amazing how investors are so easily duped. Costs reduce returns, and the higher the costs, the bigger their impact.

Where investors are usually fooled is that they are led to believe that their provider is somehow 25% to 30% better than the rest over a longer period. We are not so sure anyone can consistently claim that. There are good value options out there, so be cost conscious.

The second consideration is your choice of asset class. Investors hate volatility, but growth assets come with volatility. As a result, most dilute their returns with stabilising asset classes that have no track record of beating inflation over longer periods.

If you want to achieve returns of well above inflation, you therefore have to be prepared to live with short-term volatility. That means investing in products that predominantly hold growth assets such as equity and listed property.

Finally, something the reader has not specified is their expectations in retirement. Probably the biggest hurdle we face with individuals about to retire, is that they want to continue their current lifestyle with very limited resources.

In this particular instance, you should consider the possibility of downscaling and modifying your lifestyle to unlock the capital in your home. This will both provide more capital and potentially lower your required income.

If we use the example above and assume that you do successfully build up R3.2 million, your retirement fund grows to R425 000 (in today’s money), and that you downsize and release a sum of R500 000 from the property, then your wealth pool would be around R4.125 million. We could therefore advise taking an income of R17 325 per month before tax as prudent.

That is probably the highest sustainable income you are currently looking at when you enter retirement.