Oran Hall, Guest Writer

The segregated fund is the most popular investment vehicle for pension funds in Jamaica. But, considering the size of most funds, they may not be the most suitable vehicle.

From the point of view of the sponsors and trustees of pension funds, there are good reasons for preferring segregated funds, since these are investment portfolios that are not mixed with the assets of the managers of the funds, such as insurance companies, trust companies and portfolio management companies, or with other portfolios

Trustees or their nominees can determine how funds are to be distributed among the various asset classes to meet the objectives of the pension fund, while benefiting from the professional expertise of the manager which includes the selection of investment instruments.

Assets are registered in the name of the pension fund or its nominee. The direct ownership of assets makes it relatively easy for pension funds to change managers because it may be possible to do so without changing the name of the registered owner.

Not Suitable For Small Schemes

Though suitable for portfolios large enough to justify the cost and diversify effectively, the segregated fund is not suitable for small schemes.

Firstly, it limits the benefits of diversification, which, by distributing investible funds across asset classes, is an effective way of reducing portfolio risk and increasing portfolio returns over the long term.

Small portfolios lack the resources to buy certain assets, such as real estate, and cannot buy enough of others to impact fund performance.

Limiting the spread of investment instruments has its own problems. If the investment strategy is geared towards growth, yields tend to fluctuate sharply as markets rise and fall, but tend to be stable and below average if a conservative strategy is employed.

The latter short-changes pensioners during periods of high inflation.

Secondly, it is expensive because managers must employ more resources to give attention to each portfolio. Should it become necessary to withdraw funds, it may prove difficult to liquidate investments

A better option is the pooled investment fund which is a unitised fund - similar to a unit trust - managed by professional managers who pool and invest the funds entrusted to them in a variety of investment instruments.

The pension funds own the assets collectively.

There are two pooled fund vehicles. One combines all assets into one fund; there is one asset mix for everybody. The other, and more popular type, is divided into sub-funds, each of which invests in a particular type of asset, stocks and money market securities, for example. This allows pension funds to choose the asset classes into which they invest and in what amounts, but the manager selects the instruments.

Several Advantages

This facility offers several advantages to pension funds. It facilitates diversification of investments, thereby lowering portfolio risk and enhancing long-term returns. Management charges are usually less because managers have fewer portfolios to manage and therefore require fewer resources. By trading large volumes, managers may be able to negotiate lower transactions charges. and there is greater liquidity because money is withdrawn by surrendering units, not by selling fund assets.

A major disadvantage is that pooled funds, like segregated funds, do not guarantee returns: the pension fund take all the risks.

If pension funds lack the expertise or resources to manage their own investments, they may employ the segregated fund facility, the pooled fund facility, or both, if they are large.

The pooled fund, being cost-effective and yielding higher long-term returns with less risk, is ideal for small pension funds.

Oran Hall is senior consultant at Actman International Limited, a firm of consulting actuaries. Email: alforan@cwjamaica.com.

But are they suitable?