You wouldn’t put all your retirement savings into a five-person stokvel. Obviously not. The investor pool would simply be too small to adequately spread the risk, and the stokvel itself wouldn’t have an appropriate track record of positive returns. So while stokvels have their place in the South African savings landscape, they just don’t work in a retirement-investment context.  

The same is true for smoothed bonus funds. To get the most out of your investments, you need a fund that’s older and much, much bigger.

Protection from dilution

Why is it so valuable for a long-term investment fund to be large? “You really see the difference when you run a comparison between a newer, smaller, smoothed bonus fund and an established fund like Old Mutual’s Absolute Growth Portfolio,” says Marvin Nair, Head of Smoothed Bonus & Investment Strategy at Old Mutual. 

Old Mutual pioneered smoothed bonus funds in South Africa about 50 years ago, so it has had time to build up its books, Nair explains. “A newer fund won’t have that same advantage, which is why we see some of AGP’s younger peers offering bonuses that are about half the size of AGP’s bonuses,” he says. “Setting up a smoothed bonus book from zero is incredibly difficult, because every time a new client comes in, they may materially dilute the smoothing reserve that you’ve built up.”

That’s where the “bigger is better” factor comes into play. Larger smoothed bonus funds have a bonus smoothing reserve (BSR) that is far less sensitive to cash flow impacts.

In very simple terms, this means that if a smoothed bonus fund’s first client brings R100 million into the fund and the markets cause the underlying portfolio to grow by 10%, the fund’s bonus smoothing reserve (BSR) level will become 10%. “All things being equal, if you now get another client coming in with R100 million, that bonus smoothing reserve level will be diluted by half to 5%,” Nair explains. “The R10 million reserve now has to be spread across R200 million because you’ve doubled your book. That’s the challenge of starting from zero.”

In contrast, Old Mutual’s well-established AGP book is already R160 billion strong. “In AGP’s case, any new client we add has a very marginal dilution effect, because our book is so much bigger,” Nair says. “Of course, when the younger fund gets up and running, it may well perform in the same way – but this dilution will keep on happening until the fund reaches critical mass. That doesn’t happen overnight. And in this regard, OId Mutual has a 50-year head start.”

The more investors, the merrier

The number of investors in a smoothed bonus fund is another factor to consider. For one, it’s optimal to have a broad and diverse client base to avoid concentration risk, which can happen when a smoothed bonus fund is overly exposed to a few large investors.

“Another point is that the law of large numbers allows for greater predictability when a large group of investors are pooled together,” says Nair. “This predictability in turn allows for reasonable cross-subsidies between the investors. On a smaller fund, just one large investor leaving the pool could result in some rather volatile outcomes. On a very large fund like AGP, you don’t feel those impacts because of the sheer size.

Investors are free to choose the funds that best suit their investment goals. But it’s always worth paying attention to certain fundamental principles of investing. “Old Mutual has a broad and diverse client base, and in June 2023 our Absolute Growth Portfolio had R160 billion in assets under management,” says Nair.

“AGP’s AUM alone is far bigger than its market peers – especially the newer funds. It’s something that investors need to be aware of. In some cases, bigger really is better.”

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