The Impact on Defined Contribution Retirement Schemes in Hong Kong |
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Summary
The recent turmoil in global financial markets is
having a very real and significant impact on the
performance of defined contribution (DC) plans in
Hong Kong. Whether MPF or ORSO, many schemes
have experienced sharp drops in the overall value
of their assets. While the main cause can be
attributed to the almost universal downturn across
investment markets, there is nonetheless a fiduciary
duty for employers to ensure that the funds made
available to members are fundamentally sound,
and represent suitable investment options during
both rising and falling cycles.
Such concerns were unlikely to have been raised in recent years, which
had seen most retirement funds in Hong Kong with average growth of up
to 12 percent per annum. However, the steep fall in assets means that
scheme members will see their retirement accounts considerably down on
last year's values.
As funds continue to fall, employees are starting to ask questions on
the role of the employer, and whether enough is being done to mitigate
the decline of their retirement savings during times of market turbulence.
Investing for retirement is different
from conventional forms since it is
usually locked in over a much longer
timescale and involves investing
regular monthly amounts rather than
one-off injections of capital.
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The importance of being in the right
type of funds
The range of fund types available in the DC
market is led by those approved for the MPF
which, since its inception in 2000, has formed
the vanguard of Hong Kong's retirement system.
To regulate and simplify investment choice,
the MPF authority allows six broad categories
of funds summarized in figure 2.
ORSO schemes can include additional types,
but the vast majority will contain MPF-style
funds in the options offered to members.
Most employers set their MPF or ORSO
scheme with a pension provider, and are then
happy for members to invest from the range of
funds the provider offers. However, employers
should bear in mind that the risks for each
fund type is not always readily understood by
employees. They may not be fully aware of the
consequences of their investments - especially
when markets are falling.
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Investing for retirement is different from
conventional forms since it is usually locked in
over a much longer timescale (up to age 65)
and involves investing regular monthly amounts
rather than one-off injections of capital.
Take, for example, those approaching
retirement. They may have seen their
investments rise over the past years only to be
in a position where the final retirement amount
may now be 30 to 40 percent lower than
expected. Most of these individuals will have
been unaware of defensive strategies to protect
their retirement savings, such as switching
away from equities into capital preservation
funds as they near the end of their working life.
On the opposite end of the scale, younger
employees who are seeing sharp drops in their
retirement accounts may not realize that the fall
in prices means their monthly contributions can
buy up more units per dollar than before, and
that they still have time for these investments
to rebound and grow over the longer term.
Therefore, an important role for an employer
is ensuring that all employees understand
investment risk in the context of retirement and
that, by nature, these risks will change as they
move through their working lives.
Communication is the key tool in achieving
this, with the aim of increasing employee
awareness of how their investment decisions
affect their eventual retirement savings. |
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Figure 2: Main Fund Types Available for Hong Kong
DC Retirement Schemes |
| APPROVED FUND TYPE |
DESCRIPTION |
| Equity Funds |
High risk funds that invest in shares listed on the
world's stock exchanges. These can focus on
particular countries and regions, or be invested
into markets across the globe |
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| Bond Funds |
Low to medium-risk funds that invest in bonds
issued by both governments and major
corporations. The main factor in its value will be
the credit-worthiness of the issuing party, as well
as interest rates |
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| Mixed Asset Funds |
Medium to high-risk funds that invest in a
combination of equities and bonds, with the
proportions varying according to the investment
style of the fund manager |
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| Guaranteed Funds |
The returns on these funds are set by the fund
manager in the form of 'bonuses', with each
bonus declared annually by the fund manager
depending on how well the fund has performed
in the previous year |
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| Capital Preservation Funds |
Conservative funds that preserve the value of the
money invested, while producing returns similar
to bank deposits |
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| Money Market Funds |
Low-risk funds that look to produce a return
slightly better than bank deposits by investing
in commercial borrowing/lending and other
money markets |
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Figure 3: Annualized Returns for Approved MPF Fund Types
(as of 30 September 2008) |
| Approved Fund Type |
Past 1 year (%) |
Past 3 years (%) |
Past 5 years (%) |
Since December 2000 (%) |
| Equity Funds |
-35.4 |
3.5 |
9.2 |
3.1 |
| Bond Funds |
2.2 |
2.5 |
2.0 |
3.4 |
| Mixed Asset Funds |
-24.0 |
2.6 |
6.9 |
3.5 |
| Guaranteed Funds |
-4.1 |
1.8 |
1.7 |
1.3 |
| Capital Preservation Funds |
1.7 |
2.4 |
1.6 |
1.5 |
| Money Market Funds |
0.3 |
2.1 |
1.2 |
1.2 |
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| Inflation over the Same Period |
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| Change in the Consumer Price Index |
3.1 |
2.3 |
1.8 |
0.1 |
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| (Source: Mandatory Provident Fund Authority of Hong Kong) |
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We believe the current global financial crisis
represents the greatest challenge to the
Hong Kong DC retirement system yet seen.
Unlike the Asian financial crisis in 1998 and the SARS epidemic
of 2003, the latest drop in investment returns has occurred across
almost all asset classes, and has not just been restricted to funds
invested in the region.
Furthermore, the decline is occurring at a time when a generation
of baby-boomers are looking at their workplace pension scheme as a
major source of their retirement provision.
Up to now, employers have been able to adopt a hands-off
approach to the running of their DC schemes, abdicating the
operational issues to the providers and fund managers, and
transferring the investment risk on to employees.
However, the current situation has shown the importance for
employers to take on more stewardship and oversight. After all, it is
the company's money being invested as well.
Going forward, we expect more and more schemes to address the
issue of proper scheme governance, something which has previously
been hidden by the surge in both the economy and in the markets.
Putting in place a robust framework to oversee the way the
scheme is run will ensure that the warning signs of future market
declines can be spotted early - by the employer monitoring
performance, and by the employee through effective member-communication
- so that the necessary evasive actions can be taken.
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While employers are not directly responsible for the performance
of the funds within a DC scheme, they are however indirectly
responsible through selecting who the fund managers are. |
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Not all funds are created equal
The current financial crisis has been
characterized by simultaneous declines in almost
all major markets. This has translated into
negative returns seen by nearly all DC funds.
While employers are not directly responsible
for the performance of the funds within a DC
scheme, they are however indirectly responsible
through selecting who the fund managers are.
The capabilities of one fund manager to
another can vary significantly. Therefore, even
if the overall market shows a loss, there will still
be those managers who outperform their peers.
Downturns can also highlight which fund
managers are exercising proper controls over
their risk-taking. For example, the manager
of a low-risk bond fund which loses not only
more than its peers but also high-risk equity
funds is likely to be taking inappropriately
high levels of risk.
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However, this issue is often overlooked
during up-cycles as the positive returns distract
investors' attentions away from questioning
how the returns are being achieved.
The term, 'a high tide lifts all boats', is
analogous to how market growth can lead
to all fund managers showing improved
performance.
To truly assess the capability of a fund,
an employer should monitor the relative
performance of the manager compared to other
funds of that type, and see where they rank
against their peers.
Where the manager demonstrates
significant over- or under-performance, further
questions should be asked about how this links
in with the risks they were taking. Employers
should also probe into whether this is in line
with how their funds are being described to
scheme members.
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Alex Cheung is a senior
consultant at Hewitt's
Retirement and Benefits
consulting practice in
Hong Kong. He can
be reached at
alex.cheung@hewitt.com
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Hewitt Quarterly Asia Pacific
is made possible through the combined skills and experience of Hewitt consultants from across the Asia-Pacific region.
For further information please contact:
Hewitt Associates
2601-05 Shell Tower
Times Square
Causeway Bay
Hong Kong
Tel: (852) 2877-8600
Fax: (852) 2877-2701
editor-hqap@hewitt.com |
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