“The way things are.”
If you have seen Babe, the 1995 film about a pig who decides he would rather herd sheep than end up on the dinner table, you may remember this phrase, said in the squeaky voices of the three little mice who pop up throughout the film.
For Babe, this quote describes the rules of the farm. Pigs do what pigs are expected to do. Sheepdogs herd sheep. Farmers make the decisions. That is simply how things work.
For Subedra Reddy (pictured), executive head: actuarial services at NBC Holdings, and a father who has watched Babe more times than he probably intended to, the phrase holds another meaning.
Speaking at the Institute for Retirement Funds Africa’s conference in Cape Town this week, Reddy turned his attention to something few people enjoy paying but everyone involved in a retirement fund has to deal with: fees.
There are several ways retirement-fund fees can be charged, including a rand amount per member, a percentage of assets, or a percentage of salaries. Reddy’s focus was not simply on the amount being paid today, but on what each structure could cost as the fund grows.
“How you charge the fee makes a very big difference in terms of what that fee is going to be in future,” he told delegates.
Today’s price, tomorrow’s cost
The same starting cost can produce very different costs in the years that follow, depending on how the fee is calculated.
As Reddy put it: “How you charge the fee makes a very big difference in terms of what that fee is going to be in future.”
In simple terms, imagine having to choose between buying a BMW, a Porsche, or a Golf on AutoTrader, all for the same price: R1 million. On the surface, the money spent on each vehicle is the same. But then consider the costs that come afterwards.
Reddy estimated that the BMW could incur about R91 000 in potential servicing and running costs over the next year. The Porsche, with servicing, tyres, and ceramic brakes, could cost as much as R400 000. The Golf, by comparison, could come in at about R40 000.
Same price today. Very different costs tomorrow.
And that, Reddy suggested, is a useful way of thinking about retirement-fund fees.
“How you actually charge that fee will determine what actually is going to be in future and how that fee grows.”
The same R6.2 million
Fee structures can look remarkably similar when they are on a quotation or cost comparison. But that does not necessarily tell you what either will cost several years down the road.
As an example, Reddy created a hypothetical Fast n Furious Provident Fund, with R900m in total salaries, R1.4 billion in assets, and 5 200 members.
At the outset, the fund’s total annual cost is R6.2136m.
There are three ways to get there.
Charge R100 per member per month, or charge 0.44% of assets, or charge 0.69% of salaries.
All three produce the same starting cost: R6.2136m.
So, if a trustee is looking only at today’s number, there does not appear to be much difference.
But Reddy’s model does not stop at today. He projects the three structures over 40 years, using assumptions of 6% inflation, 7% salary inflation, and an 11% investment return.
The lines begin to separate.
A rand-per-member fee grows with inflation. A salary-based fee grows with salaries. An asset-based fee grows with the value of the fund, and the difference compounds over time.
By the end of the 40-year illustration, the asset-based fee is 5.1 times the rand-per-member cost and 3.5 times the salary-based cost.
The point is not that the three structures have different starting prices. They do not.
It is that the same R6.2m starting cost can lead to very different costs over the life of a fund.
When ‘normal’ no longer tracks
Reddy took the asset-based structure a step further.
He asked delegates to imagine sitting in front of their boss for an annual performance review. They had three KPIs. They missed all three. Then, despite the poor performance, they asked for a pay increase.
The answer, Reddy suggested, would be obvious.
“You’re fired.”
Yet with an asset-based fee, if the market rises by 20% and the fund’s assets grow by 20%, the fee rises by 20% too.
Reddy illustrated the point by asking delegates to consider a market that delivers 25%, while their fund manages only 20%. Despite the fund underperforming that benchmark, the asset-based fee would still increase by 20%.
“But the way our industry is structured is that we actually accept this, right? This is normal.”
Reddy was not arguing that every asset-based fee is inherently wrong. His concern was that the industry may have become so accustomed to the structure that it is accepted without enough attention being paid to where it leads.
“I don’t think it makes sense,” he said. “But it just suggests the way things are.”
The cheapest option today
There is another trap, he suggested.
Imagine a cost comparison between three service providers. One quotes R6.2m. Another quotes R6m. The instinct is obvious: choose the cheaper one. But what if that R6m is attached to a fee structure that grows much faster?
Reddy’s concern is that cost comparisons can become too focused on the number in front of trustees today, rather than the trajectory of that number.
“We just accept the fees the way they are, and we keep on paying them over and over and over,” he said.
He also pointed to a pricing trend in the industry where certain components of a service may be presented as “free”. For example, a provider may offer a 0% charge on one component, while structuring the overall offering around a higher asset value. The apparent saving can make the option look cheaper when the initial cost is compared, but if the fee is linked to assets, the growing value of the fund can result in higher charges over time.
In other words, a fee that looks attractive because one component is free cannot necessarily be assessed in isolation. Trustees also need to consider what they are paying on the assets, how those assets are expected to grow, and what that means for the total cost in future.
The calculation should extend beyond the figure presented in a quotation.
“It’s not just what am I paying today, but what am I going to pay tomorrow? What am I going to pay in a year’s time, five years’ time, and 20 years’ time because we all want our funds to be around in 20 years’ time.”
What the fees mean for members
That is from a fund’s perspective, but what does a fee structure mean for an individual member?
Reddy used a hypothetical member, Sipho, who is 20 years old, starts with no accumulated retirement savings, earns R170 000 a year, contributes 12%, and retires at 60.
For a young member starting from zero, an asset-based fee can initially work in his favour. There are no meaningful assets on which to charge the percentage, so the fee starts very low.
For roughly the first 25 years, Reddy’s model shows little difference between the three fee structures. As Sipho’s retirement savings accumulate, however, the asset-based fee begins to pull away.
During the final 15 years of the 40-year working life, the difference becomes much more pronounced. By the end of the illustration, the asset-based fee is roughly double the cost under the other two structures.
Which fee structure is “best” depends on the fund, the member, and the time horizon.
What looks attractive at age 20 may look very different at age 50. And what looks cheapest when a trustee is comparing quotations today may not remain the cheapest option as the fund grows.
A fee you can actually understand
Reddy had started his presentation by pointing out how difficult retirement-fund fees can be to identify and calculate. There are multiple types of charges, some of which may not be obvious from financial statements, while the amount ultimately paid can depend on how the fee is structured.
By the end of his presentation, his focus was on making that calculation easier for the people who have to live with it.
“How about as an industry we start charging fees that our trustees can understand?”
“And how about as an industry we start charging fees that our members can understand?”
“How about starting fees that you don’t need a spreadsheet to work out?”
That does not mean every retirement fund has to use the same fee structure. It means trustees and members should be able to see what they are paying, understand how the cost is calculated, and have a reasonable idea of where it is heading.
The way things are is not necessarily the way things have to remain.
