Greater employer oversight needed
Retirement schemes and their members across Asia have been badly hit by the financial market collapse. The fall in pension fund assets has resulted in a crisis of confidence. As funds continue to fall, employees are starting to question the role of their employers, and whether enough has been done to halt the decline of their retirement savings during these turbulent times. For defined contribution schemes that give individuals a choice of investments - such as the Mandatory Provident Fund (MPF) in Hong Kong and ‘Section 5’ Retirement Schemes in Singapore - there is a fiduciary duty for employers to ensure the funds made available are fundamentally sound, and represent suitable investment options during both rising and falling cycles.
Most company schemes involve the sponsoring employer choosing a third party pension provider, such as a bank or an insurance firm. The employer is usually happy for members to then invest from the range of funds the provider offers. However, employers should bear in mind that the risks for each fund type is not always readily understood by employees. Investing for retirement is different from conventional forms, since contributions are usually locked in over a much longer timescale and involves investing regular monthly amounts rather than one-off injections of capital.
Take for example those approaching retirement, who have seen their investments rise over the past years only to be in a position where the final retirement amount may now be 30-40% lower than expected. Most of these individuals will have been unaware of defensive strategies to protect their retirement savings, such as switching away from equities into capital preservation funds as they near the end of their working life. On the opposite end of the scale, younger employees who are seeing sharp drops in their retirement accounts may not realize that the fall in prices means their monthly contributions can buy up more units per dollar than before, and that they still have time for these investments to rebound and grow over the long term.
Therefore, an important role for an employer is ensuring that all employees understand investment risk in the context of retirement, and that by nature these risks will change as they move through their working lives. Communication is the key tool in achieving this, with the aim of increasing employee awareness of how their investment decisions affect their eventual retirement savings.
The current financial crisis has been characterised by simultaneous declines in all major markets and has translated into negative returns seen by all pension funds. The chart below shows the drastic fall in annual returns for investment funds within the Hong Kong MPF, which is one of the most mature retirement systems in the region.
Whilst employers are not directly responsible for the performance of the funds within their retirement scheme, they are however indirectly responsible through selecting who the fund managers are. The capability of fund managers varies greatly, as a glance at MPF performance tables shows clearly. The contrast is greatest in a downdraft, where the skillful fund manager is separated from the beta-monkey. Downturns also highlight which fund managers are exercising proper control over their risk-taking. The manager of a bond fund that loses not only more than its peers but also more than an equity fund, is likely to be taking inappropriately high levels of risk. However, this issue is often overlooked during up-cycles, as the positive returns distract investors’ attention from questioning how the returns are being achieved.
The term ‘a high tide lifts all boats’ is analogous to how market growth can lead to all fund managers showing improved performance. To truly assess the capability of a fund, an employer should monitor the relative performance of the manager compared to other funds of that type, and see where they rank amongst their peers. Where the manager demonstrates significant over or under-performance, further questions should be asked on how this links in with the risks they were taking, and whether this is in line with how their funds are being described to scheme members.
The current global financial crisis represents a major challenge to the retirement systems of countries in the region. Unlike the Asian Crisis in 1998, when currency collapses sent pension investments into freefall, the latest drop in investment returns has occurred across all asset classes, and has not just been restricted to funds invested in the region. Furthermore, the decline is occurring at a time when a generation of baby-boomers are looking at their workplace pension scheme as a major source of their retirement provision.
Up to now, employers have been able to adopt a hands-off approach to the running of their schemes, handing the operational issues to the scheme providers and fund managers, and transferring the investment risk onto employees. However, the current situation has highlighted the need for employers to take on more stewardship and oversight - after all, it is the company’s money being invested as well.
In future we expect more schemes to address the issue of proper scheme governance, which has previously been hidden by the surge in both the economy and in the markets. Putting in place a robust framework to oversee the way the scheme is run will ensure that the warning signs of future market declines can be spotted early - by the employer monitoring performance and by the employee through effective member-communication - so that the necessary evasive actions can be taken.