Historically, investment returns in most defined contribution retirement funds were in smooth bonus portfolios.
Smooth Bonus Portfolios means that investment returns would be held back during years of good investment performance in order to make better declarations during years of poor investment performance by releasing reserves to the fund member.
Problems with this approach (e.g. changes to legislation aimed at avoiding generating surpluses at the expense of members leaving retirement funds) have led most funds to cease smoothing and instead allocate actual investment returns to members; whether positive or negative.
The move away from smoothing made the concept of risk versus return clear – to achieve a higher return, be prepared to accept more risks. With investments, this means that those asset types that are the most volatile in the short-term (e.g. equities, shares in companies), give the best return in the long-term. So, to avoid short-term volatility, invest more conservatively and this means sacrificing long-term investment returns.
This practice has effectively created a “one-size fits all” approach to investment strategy and investment returns, whereby all members would receive the same treatment. During times of positive investment performance this would not be seen as a problem, however, it becomes a serious matter during times of poor investment performance, because values from previous years may be reduced.
Younger members are still far from retirement, therefore short periods of poor investment performance should not trouble them too much. They still have a long time to go before retirement and during that time the investment performance could recover. Older members, however, do not have this luxury, especially members of provident funds who have the option of taking a lump sum benefit at retirement. They need the peace of mind of stable investment returns during the time period close to their retirement so they are able to plan ahead.
The graph depicts how a single investment of R100 invested in May 2004 would have accumulated to, for a typical fund that provides two investment strategies: an aggressive strategy for most members and a conservative investment strategy for those members within three years of retirement.
