He made his comments at the consultancyÆs annual seminar on manager investment performance in Hong Kong, which as usual attracted the bulk of the territoryÆs asset management community. Watson Wyatt uses the high-profile morning to showcase the latest ideas in global investment management, although this year it did not detail results from its annual survey of institutional money management in Hong Kong.
In addition to tackling reform of Hong KongÆs retirement schemes, Watson Wyatt consultants also underlined the importance of improving fund governance in order for investors to be able to manage the growing need to diversify into alternative investments.
Tso took an example of a balanced fund allocating 70% to equities, which would be up an accumulated 40% since inception in December, 2000, gross of fees. But include the market average fees of 2% (half for management, half for admin and custody) and total returns fall by 7%. ThatÆs just for five years, Tso notes û imagine the impact on returns by 2% fees over 25 years? He says assuming an annual 7% return on investment, 3% inflation and 5% salary inflation, that 2% fee will net an MPF member HK$7.5 million.
But replace that with a flat monthly fee of HK$300 per member, and over 25 years, membersÆ net return rises 10%. Charge a flat monthly fee of HK$100 and the member will accumulate around HK$9 million û a 20% gain.
Tso acknowledges that flat fees discriminate against those members with small MPF portfolios. But he believes this is outweighed by a flat rateÆs simplicity, its propensity to encourage more savings and consolidation among preserved accounts, and its increased appeal should MPF system benefits improve over time. Tso notes that the market can determine flat fees, as happens in places such as Australia and the United States.
Tso also said the idea of allowing members to choose their MPF provider should be discussed, although Watson Wyatt didnÆt take a stand on this. Provider choice would foster more competition in terms of product and price, and would build public awareness. But choice can also create confusion, open the door to mis-selling and add to administrative burdens. Tso also called for payments to have an annuity payout option but didnÆt give details on how this would work in Hong KongÆs context.
Much of the rest of Watson WyattÆs presentation focused on trends among top-performing pension funds worldwide. Naomi Denning, regional managing director for investment consulting, provided an entertaining roundup of trends in various markets in the format of a TV news broadcast. Various Watson Wyatt consultants based around the world reported a steady diet of good news, thanks to favourable equity market conditions û but also noted that leading pension funds are increasingly diversifying into hedge funds, property, infrastructure, global tactical asset allocation, private equity and commodities.
What Denning didnÆt say was whether Hong KongÆs institutions should do the same, but the local client base is known to maintain a very traditional asset mix.
Roger Urwin, London-based head of investment consulting for the firm, contributed with examples of how world-beating pension funds achieve consistent out-performance. The key is good governance, he argues, which in turn sets conditions for successful investment and manager decisions.
Again, he didnÆt comment on the level of fund governance among most Hong Kong institutions, but most investors in the territory would probably not be ranked as world class in this regard.
ThatÆs because good governance comes with a cost. It requires trustees who are diligent, financially literate and understand how probability works. These skills are not common, therefore top pension funds in the US and Canada are willing to remunerate their pension trustees to reflect this. Urwin says this is why North America has so many of the worldÆs best pension funds, and notes this trend is spreading to other regions. He argues that, although changing fund governance is difficult, it can be managed, and will result in better investment performance.
Finally, senior consultant Peter Ryan-Kane encouraged investors to take a long view and incorporate macro factors into their planning, because global economic growth accounts for a major part of equity returns. Sophisticated pension funds will consider factors such as demographics, public policy, geopolitics, energy, the environment, the rise of emerging markets such as China and India, and rich-country investor sentiment. Ryan-Kane argues that by developing views on these big-picture trends, investors can develop views on risk and return for particular regions, sectors and countries.
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