Rob Southey, Head: Asset Consulting at Momentum Consultants and Actuaries

The Two Pot system has been under way for almost a month now, and while there are a few administrators who still need to get the process under way, the facilitation of seeded savings pot payments has progressed well. There have been glitches and some unintended consequences, and frustration about taxes that are deducted, but on the whole the process is working well. So, what now?

One of the areas that has not been spoken about much until this time, and for good reason given everything else that needed to be done, is the investment strategy of the savings pot.

Industry advisors have cautioned trustees / advisory bodies not to make hasty decisions about changing their funds’ investment strategies to accommodate their members’ anticipated Two Pot withdrawal needs. Decision-makers are encouraged to observe and understand member behaviour over a period of time before looking at the extent to which liquidity is to be added or volatility to be reduced from the portfolio.

While this is accurate, we need to consider the extent to which one member’s behaviour could negatively prejudice another member’s investment outcomes.

Going back to first principles, for the majority of members, there are three pots – the vested pot, the retirement pot and the savings pot. For the purpose of this article, we will only focus on the savings pot.

As with any investment strategy design process, you need to know what you are trying to solve for. And immediately things become complicated. Because, as far as the savings pot is concerned, we don’t necessarily know what we are solving for.

We know that some members will see the savings pot as being invested for retirement, and those members will typically adopt the same investment strategy in the savings pot as they do for the vested and retirement pots.

But what about members who see the savings pot as a bank account that will be tapped into on an annual basis? We could say that all retirement investments are for retirement, but we have come to learn that this is not necessarily so, and that many members need to access the savings pot to meet ongoing living expenses. This is an unfortunate reality.

Consequently, a member of a fund who is going to be using the savings pot for frequent access, will want a portfolio that provides capital preservation. (In a previous article (and video) we demonstrated the impact on retirement values for portfolios invested in money market instruments and suffice to say that investing in a money market portfolio and / or withdrawing from the savings pot has a significant impact on member retirement outcomes). At the same time, a member of the same fund, who does not want to make withdrawals from the savings pot, will want an investment strategy that is consistent with their term to retirement – lets say a high equity balanced fund.

So, who do the trustees / decision-makers cater for and how do they prevent one member’s behaviour from prejudicing the investment outcome of another? Do they invest conservatively to cater to the “drawer”, or do they invest for the longer term to cater to the “saver”? This is not an easy decision as either way they prejudice one party. Decision-makers may even be inclined to vote with the “side” that makes the most noise.

So, what to do? The apparently obvious solution is to offer member investment choice in the savings pot! For example, the default is to invest in a strategy that caters to long term investing (including lifestage, etc.) and members who want capital preservation can make a member investment choice to invest in a capital preservation portfolio. This way, no member is prejudiced by the behaviour of another member.  Having a capital preservation savings pot default would also need to be tested for compliance with the “Principles” of Regulation 28 and Regulation 37.

While member choice might sound like an obvious answer to this particular problem, it adds complexity to member investment defaults, member understanding of their investments, member communication, as well as the ability of administrators to facilitate this (at present, some can, most can’t). So, in retrospect, this is not an easy decision.

ENDS