SME? Are umbrella funds right for you?

In a country where entrepreneurship and small to medium-sized enterprise development play a pivotal role in alleviating high unemployment rates, umbrella funds meet a very specific requirement. However, despite a push by the industry at large, umbrella funds aren't the most appropriate option for all companies, says Walter van der Merwe, CEO of FedGroup Life.

Faced with changes to legislation that require investment administrators to apply for and obtain the approval of the Registrar of Pension Funds, in accordance with section 13B of the Pension Funds Act, along with more onerous compliance and capital reserve requirements, a number of players have pushed larger companies into umbrella funds to create 'super funds'.

The rationale behind this isn't sound, as large companies can benefit greatly from standalone funds.

First and foremost, a standalone fund gives a company more control of the structure of the fund, which means it can be tailored to meet very specific requirements. In terms of retirement funds, this can be used as a powerful differentiator as it shows that the company has a vested interest in the benefits offered to its employees. Obviously this approach comes with a responsibility to the employer, who needs to be proactive in terms of managing the fund. However, with the commensurate staff volume the administrative costs can be subsidised across the employee base to make this a viable option.

For smaller companies, which don't have the same employee volumes, nor the expertise or the luxury of hiring dedicated resources to take this approach, umbrella funds are often a better option.

However, there is a great deal that could be done to change umbrella fund structures to make them more appealing and cost-effective. For instance, many funds today are unnecessarily complex as fund managers try to differentiate themselves to attract business, but this is often to the detriment of the saver.

Administration costs should also be an explicit cost per member that is recovered from monthly contributions. However, numerous umbrella funds charge asset-based management fees, which increase in relation to the sum invested. This penalises those who save more, which makes no sense as the industry should be helping to promote retirement reform in line with government's mandate, particularly by reducing the costs associated with saving.

These costs are also not explicitly shown in reports. They're in the documentation somewhere, but aren't always clear. This lack of transparency is a major concern, and is a key area that requires immediate reform.

These changes would go a long way to increasing the affordability of umbrella funds, ensuring more citizens have access to efficient retirement savings and a broader spectrum of employee benefits. It's also often difficult for smaller companies to carry the increased payroll overheads associated with umbrella fund investments, particularly in the current economy. The forced deductions on staff salaries can also burden already tight household budgets. The industry needs to look for ways to make this form of investing more affordable, such as a tax rebate for smaller employers.

Despite these shortcomings, umbrella funds already offer great benefits and value. For instance, umbrella funds are still more cost-effective than standalone funds, and companies don't need to worry about the administrative burden and legislative compliance requirements. This means they can focus on their core business to ensure sustainability and growth.

Umbrella funds also spread risk and remove the burden of managing that risk in a field that the employer is not an expert in. This, however, doesn't absolve an employer of being proactively involved as they need to constantly communicate fund-related information to employees, particularly where money is being invested, fund performance, and the associated costs.

Group risk benefits also become more affordable through umbrella funds as they're cross subsidised. They also offer employees easy access into passive investments and employee benefit schemes as everything happens through the company, not a broker on an individual basis, which attracts more costs and commissions.

Lastly, the larger pool of contributors in an umbrella fund creates a bigger asset base, which means better fee structures can often be negotiated, and bigger investment opportunities become available, which can be taken advantage of to deliver better real returns.

Umbrella funds are therefore a great way for an employer to give employees access to a wide range of benefits, including retirement savings, at a cost-effective rate.