The Trend Towards an Integrated Approach
By John Anderson, Executive: Investments, Products and Enablement, Alexander Forbes
Over the years, there have been many debates on whether split service models (where different service providers are utilised) compared to integrated providers (where core functions such as investment strategy design, asset manager selection and investment administration are combined by a single provider) are better in delivering reasonable outcomes for retirement fund members.
This applies to how investment strategies before and after retirement are designed and executed, as well as whether the running of a fund should be on a standalone basis or whether to make use of an umbrella arrangement with pre-packaged solutions.
The overall objective of a retirement fund is to provide a good outcome for members. The following factors, amongst others, are important for members to achieve good outcomes:
- achieving sufficient real returns on their retirement savings whilst they are employed; and
- ensure that their arrangements are administered efficiently and securely.
Overall, the appropriateness of a split-service or integrated approach should be based on which approach delivers the best outcomes for individuals in the areas above. The next sections look at each of these aspects in turn.
Achieving good returns on retirement savings whilst saving during employment
Below we have analysed the net returns over the 10-year period to 31 December 2020 for various growth portfolios used to accumulate savings before retirement. The analysis was based on available information on large retirement funds utilising a split-service approach (with the main providers who dominate in providing advice to these funds using a split-service approach). This was then compared to the average retirement fund (as measured by the Alexander Forbes Global Large Manager Watch median returns), as well as an integrated multi-manager approach as represented by the Alexander Forbes Performer portfolio.
We also provide risk / return analysis for the 3-year period where the information was available.
As is evident from the above, the long-term returns indicate that the integrated approach consistently outperforms the split-service approach and the more recent information indicates this being achieved at lower risk.
We expect that going forward an integrated approach will continue to provide better outcomes, in terms of greater returns at lower risk whilst doing good, for the following reasons:
- the increasing complexity of the investment market and the need to respond to these changes more quickly
- the increasing specialisation in specific areas such as private markets, infrastructure and incorporating ESG into investment processes
- the need for pooling assets for liquidity purposes and to reduce overall transaction costs
- the associated skillsets needed to research the various areas in the market
- the fact that with an integrated approach accountability is given to the multi-manager in terms of the end outcome
- the fact that when things go wrong, the risk of different providers blaming each other is removed.
At the same time, the approach assists trustees and employers to simplify how they run their arrangements and reducing the regulatory risks they face by managing more of the complex investment decisions themselves.
Ensuring efficient and secure administration
Ensuring efficient and secure administration of your retirement savings is critical to ensure a good outcome. Amongst other things, three key operational components need to be in place in retirement funds to ensure sound administration of members’ retirement savings. These are:
- A member-record administration system that can accommodate daily unit prices
- An investment administration platform that can calculate daily unit prices
- An ongoing monitoring framework to ensure that a fund’s underlying assets (as reflected by the investment administration platform) matches its liabilities (as reflected by the member-record administration system)
The function of enhanced financial analytics is to reconcile transactions between the member administration system and the investment administration platform.
For ongoing monitoring to be successful, the member administration system and investment administration platform must be compatible and allow the enhanced financial analytics function to integrate across each area’s systems and processes (i.e. an integrated approach is critical).
Key reasons to ensure integration between the member and investment administration systems include:
- Ensuring that all systems are appropriately amended where regulations change (e.g. default regulations introducing default preservation and annuity strategies), and that there are no gaps in the ultimate implementation in relation to a fund’s chosen strategy.
- Reducing the time lag between when unit prices are calculated and when those unit prices are applied to member records.
- Ensuring that all checks between assets and liabilities factor in any changes or enhancements across either the member administration or investment administration systems.
- Ensuring that there is accountability for errors. Where multiple providers are appointed, errors may prompt providers to blame each other rather than putting members in the position they should have been.
Whilst there are pros and cons of both split service and integrated models, the trend is increasingly that integrated models provide better outcomes as opposed to split service models, removing the burden for fiduciaries such as trustees and employers as well as being better suited to keep pace with changes. This trend is evident internationally, where the concept of an “outsourced CIO model” has become increasingly popular in managing retirement fund investment strategies (as opposed to services being provided by separate service providers). This has been in response to the challenges brought about following the global financial crisis in terms of low interest rates, market volatility, low growth, increasing regulatory and compliance burden and access to the broad skillsets needed to ensure good returns to members. With the introduction of “pooled employer plans” in the US, more employers are also outsourcing their retirement fund arrangements –similar to the trend in South Africa where more employers are utilising umbrella funds rather than running their own standalone retirement fund arrangements. The recent challenges brought about by the Covid-19 pandemic have further accelerated these trends.
In South Africa, we have similarly seen an increasing trend of funds moving from a split service approach, to an integrated approach. We expect this trend to continue as evidence demonstrates the value of an integrated approach and as trustees and employers aim to reduce the keep pace with developments and simplify their arrangements.
In addition, the recent Covid-19 pandemic has shown the importance of ensuring that systems can withstand shocks to the system. This requires integrity of systems and that there is full ongoing alignment between assets and liabilities. It has also highlighted that funds need to leverage off available technology to engage with individual members on an ongoing and timely basis. This can only be done when systems are fully modernized, using the latest processes, governance and engagement tools.