What drives the performance of retirement vehicles?

Dubai: I was minding my own business when a Gulf News reader tells me that all newspapers assume (and do so incorrectly) that their readers know and understand precisely what a retirement plan is and precisely what drives the performance of these vehicles!

Bearing in mind that the Gulf News is getting to the age of the average term of savings for a retirement vehicle, perhaps this is a good time to satisfy one reader. And, if Mr J is right, take a "journalistic lead" on defining retirement planning. Here goes.

Let's start with definition. Easy: there is no one-glove-fits-all definition of a retirement plan. The best we might get: An asset or pot of assets that produces an income after retirement. Maybe the pot is provided by your employer (former employer) maybe you have built the pot yourself.

Either way, the motivation for building the pot (the long-term savings process) remains the same: The financial planning conundrum we all face, i.e. what do we do if we die too early (clue: life insurance); what do we do if we die too late (clue: retirement savings that last forever).

Whilst fairly happy with my superficial beginning, Mr J isn't. "That doesn't explain the difference between pensions, 401(k)s, provident schemes and so on" says the 30-something-year-old with all the "won't-go-away" enthusiasm of a seven-year-old.

If he was trying to be really awkward I suppose he could have thrown in Australian Superannuation planning, and the laws applied to Indian and Canadian trusts to draw down income in retirement. Back to the superficial: "Same horse different jockey," I say.

Different pots

They are all "retirement pots" in which assets are managed for a post-retirement benefit. (To anyone "getting funny" with me on the fact that you can arrange many trusts and retirement plans on the basis of pre-retirement benefit and income, I say: you are missing the need for the superficial for explanatory purposes. An excuse that works for me).

Mr J's provocation leads to the recognition that many countries have established their own sets of rules applied to "retirement drawings". The so-called "graying revolution", whilst good for hair-dye sales means that improved life-expectancy adds to the burden of government in looking after their aged. It makes sense for government to provide tax breaks on non-government initiatives that reduce the government's future burden. Employer-sponsored savings and self-saving initiatives have therefore been widely encouraged by governments.

Tax breaks vary from country to country, as tax laws and levels vary so widely. Sweden for example can boast one of the highest levels of mutual fund savers in Europe. When you look at the historically onerous level of Swedish tax and look at the tax breaks on life insurance policies there would be no surprise to see mutual funds wrapped in tax efficient life-wrappers!

Mr J's provocation is timely. After all, if the markets have just dropped tens of per cents, and if you can "make" (by not paying) tens of per cents in tax benefits it means that expatriates should take real care in understanding what drives retirement income performance. So for Mr J, I have devised four superficial levels.

Level One - Product Wrapper: The Product Provider has, potentially, four significant impacts on "post-retirement performance". For anyone who finds five: remember my survey is superficial! These points amount to a useful "check list" of issues to cover with any financial planner when it comes to investigating the "value-add" of a product provider. Brand value of the Product Provider has a negligible connection to the "value-add" of the product to the investor. Firstly, the Providers Product range. Does it allow you to take your "savings pot" back to your base country and withdraw income by exploiting tax efficient incentives in that country? This is the point induced by Mr J's continual pressing: "Why are there so many different retirement plans?" The answer: there are many places to retire to and it's worth being sure that you are using a product that exploits tax breaks in your end-use country.

Secondly, what are the charges associated with the product and what is the impact if you needed to withdraw your funds early? Thirdly, does the provider have "asset pots" that allow you to withdraw income in the currency of your end-use? If you are taking "currency risk" in retirement- you really need the in-depth, non-superficial overview. Finally, what assets are available within the product providers "stable" of assets and do they allow you to run with a performance strategy close to your attitude-to-risk? Four points for level one, but largely only indirect effects on performance. Product wrappers are not "performance engines".

Level Two - Asset Allocation: Professor Brinson and others studied US pensions over a number of years and concluded that over periods of around 5 years the biggest impact on performance was "asset allocation". Not market timing, not specific stock selection. Simply put: the "weight" you are holding of different assets: how much did you have in equities when the markets went up, how much did you have in equities when the market went down? Brinson's views remain the dominant influence on pension-performance analysis. It may be that an "argument" is breaking out amongst the academics on what assets should be made available for the "allocation" to be debated. No one is debating whether the allocation is important. If your adviser(s) do not understand this- change them.

It means that there is some pressure on the investor/saver needing to understand WHO is doing the allocation. Who is managing it? Who is taking responsibility for it? Rarely is this the job for a financial planner.

Level Three - Fund Manager: Confusion sometimes reins between levels two and three especially where fund managers are actually undertaking two roles: that of asset allocation and that of fund management. The "multi-manager" philosophy is one that utilises one manager in managing a number of other fund managers in order to get an overall portfolio result.

"Balanced Funds" undertake similar roles. The critical point here is" does the retirement-saver know who is undertaking the overall asset allocation policy role and who is managing the funds?

Of the universe of fund managers, the vast majority of them are "performance benchmarked". They are not benchmarked to Your retirement "asset pot". It means that the process of separating the "asset allocator" from the fund manager, includes the process of establishing the performance benchmarks for your retirement pot, and separating that mark from those of the underlying funds. Retiring to India? Then the Dow Jones benchmark, the hedge fund indices, the commodity indices are totally irrelevant to you. They may not be, however, to some of the funds you are using.

This leads to Level Four: The Markets. Capital Markets are significant underlying influences on performance not least because few funds and asset allocators use assets that are in the "private" arenas.

Whilst I am sure you will find exceptions to the comment, the fact remains that the retirement savings and post-retirement income world is market dominated. Access to the market is through you fund manager and/or the asset allocation policy. The greater the wisdom in the asset allocation and use of funds the greater the probability that market turmoil is used for your benefit.

In the final analysis, markets can be stressful if misunderstood. The key is the "understanding" which comes from retirement savers having their expectations, their tolerance-to-loss being managed effectively. This means an understanding of all four levels of the retirement product nexus. Superficial but important.

- The writer is chairman of Mondial Financial Partners.