Treasury’s new default regulations for retirement funds are set to come into full effect from today. Among other things, they will require retirement funds to have a suitable default investment portfolio in place for pre-retirement savings that is not excessively complex or unreasonably expensive.
Pavit Ramnarain, Actuary at Momentum Corporate, believes that trustees will be best positioned to achieve this for their members through an outcome-based investing model. He outlines several factors for trustees to consider when deciding on a default investment portfolio.
1. Consider the member profile and their desired retirement outcome
“Default investment portfolios are applicable to members who do not specifically choose how their retirement savings should be invested. This means that a default investment portfolio should consider the investment objective, underlying asset allocation, fees and charges, as well as expected risks and returns,” says Ramnarain.
“This requirement is aligned with Momentum’s Outcome-based Investing philosophy, which places the investor’s needs at the centre of the investment process to align investment and personal goals”, he explains.
According to Ramnarain, it is crucial that a default investment portfolio provides an opportunity to generate inflation-beating returns that will maintain the purchasing power of members’ savings – and for those members who cannot withstand the market volatility, the portfolio should also offer a capital guarantee to protect them against adverse market movements.
2. Find a balance between protection and cost
Ramnarain believes that a new era of smooth bonus portfolios is required for this type of solution to be considered as a default option. This, he explains, is because while the smoothing process reduces the impact of market volatility on the member’s investment, there is a high cost associated with the guarantees that are typically associated with smooth bonus portfolios.
“These guarantees, while integral to capital protection when the market is not performing, can be so expensive that they actually end up eating into returns, because the capital charges are normally deducted from a member’s growth,” he says.
According to Ramnarain, Momentum’s new low cost smooth bonus solution resolves this by reducing the guarantee charge through the solution’s design. He adds that costs have been further reduced by utilising a combination of passive, smart-beta and active investment strategies. Smart beta emulates the lower costs of passive investing while still capturing some benefits of active management.
“By reducing the capital charge and applying a combination of investment strategies, the total cost of the fund will be reduced, which means more money can be channeled towards members’ accumulated retirement benefits,” he says.
3. Communicate effectively
Finally, Ramnarain explains that the new default regulations also require the ins and outs of the default investment portfolio to be disclosed to members in understandable language – including the pricing structures, which members always find difficult to interpret.
“The default regulations are intended to improve members’ retirement outcomes by ensuring that an appropriate investment portfolio is in place for those members that do not select one. If implemented effectively, we believe that the default investment regulations will go a long way to achieving the intended outcome” he concludes.