Regulation 28 offers opportunity for improved retirement outcomes but greater flexibility requires more care and skill
Higher offshore limit of 45% allows for further diversification and offers additional growth opportunities, but the wider choice and competitive global landscape means South African retirement funds must exercise caution and build their expertise to ensure they construct robust portfolios that are aligned to members’ objectives, notes Andrew Davison, Head of Advice at Old Mutual Corporate Consultants.
As South Africa comes to terms with sweeping retirement fund reforms that have been in the making for more than a decade, the country stands at the cusp of changes that could substantially move the dial on retirement outcomes.
Among the recent reforms is the amendments to Regulation 28 of the Pension Funds Act, which now allows retirement funds to invest up to 45% of their assets offshore. Before the amendment, the offshore asset limit was 30%, with a further 10% allocation to the rest of Africa.
The changes mean the 10% allocation that was ring-fenced for the rest of Africa — an allowance that was seldom fully utilised — has been rolled into the general offshore allocation, which now stands at 45%.
The reforms could not come at a better time with respect to South Africa’s well documented retirement savings crisis. This crisis was brought home in May 2022, when Old Mutual Corporate research invited eight South African families to participate in a social experiment testing their preparedness for the day the breadwinner reached retirement. Each family was tasked to fill a shopping trolley with all the groceries they needed in a month. They did not know that their budget was constrained to what it would be based on their retirement savings and ongoing contributions and hence their projected income when the breadwinner retires.
The results revealed that every family was over their future household budget – some as much as 800% – revealing that most South Africans will be unable to maintain their standard of living post retirement. With this situation in mind, the relaxation of limits within Regulation 28, if managed wisely, offers retirement funds an opportunity to build more resilient investment strategies to target improved retirement outcomes.
The amendment’s most pressing advantage is the flexibility for retirement funds to access a wider set of opportunities for growth as well as diversification.
The higher offshore limit is good news for investors and savers because it provides greater opportunities for asset managers to seek out high-quality investments across the world. This not only allows portfolios to be more diversified, but also gives investors more opportunities by including companies or industries that are not available in South Africa as well as regions or sectors experiencing high growth rates.
Further changes to Regulation 28 have sought to encourage investment by retirement funds into infrastructure assets, which coincidentally, also have an upper limit of 45%. This greater focus on infrastructure has thrust alternative and private markets to the fore. Retirement funds are able to allocate assets to private markets such as private equity funds, which have a limit of 15%.
The amendments also bring South Africa better in line with global capital structures which is important in an increasingly interconnected world and enhances the country’s ability to trade and deal with other countries. This standardisation is especially important for a small, open economy like South Africa as it facilitates trade and flow of money and improves our global appeal to foreign investors. In this way, it is hoped that a virtuous circle will see assets flowing into South Africa, creating further opportunities for growth.
Capital flows to places where it can achieve better returns commensurate with the risk and with minimal effort and hassle. Higher levels of risk, along with any constraints and administrative obstacles, mean that a particular project, company or asset must generate higher returns to compete and make it worthwhile to prospective investors, be they local or foreign. The alignment produced by these foreign exchange changes means that our economy is more attractive to investors who have a greater degree of confidence in our compliance to global financial norms.
The challenge of short-term outflows
Although the relaxation of the limit may see some selling pressure on SA markets as asset managers rebalance their portfolios over the next year or two, this is likely to be short term. In the longer term, the increased attractiveness of South Africa to foreign investors, based on the relaxation of exchange controls, plus the continuous flow of returns from the offshore assets back into the pockets of South African retirement fund members, is likely to result in better growth opportunities for the country, better profitability for companies and hence better returns for investors.
Proceed with caution
With greater choice comes greater responsibility and a greater need to exercise that choice responsibly. Having a wider range of options will require more careful thought, more investigation and research and additional work and this will test the mettle of local asset managers who have until now largely been focused on South African assets.
Under the more restricted regime, choices were somewhat easier. The relatively low offshore limit of 30% meant most of this allocation went into offshore equities. Now the limit is such that it is effectively an almost unconstrained environment so the allocation of up to 45% is a much more material part of the whole investment strategy. This means more careful thought about decisions like the asset classes to be used offshore, rather than just equities, the regions and countries to have exposure to, rather than just a global mandate, and even whether to hedge a portion of the currency, rather than just have unhedged Rand exposure.
Managers must also think more carefully about what’s taking place in countries where they have investments. This increased complexity means local managers may have to partner with international managers to capacitate and benefit from their expertise and global reach to mitigate risk and harness research capacity.
It’s not possible for asset managers to analyse the full gamut of thousands of global investments and consistently select only the best investment opportunities. Competing with asset managers who are experts on their own country’s investment landscape is difficult.
The reality is that few South African asset managers have the capacity and expertise to research and select global stocks or bonds or property or any other asset class so they may have to consider teaming up with offshore asset managers who have the necessary knowledge, skills and structures.
Impact on costs
Depending on the structures involved in accessing offshore investments, the type of investment approach used, arrangements with global partners and a host of other factors, accessing offshore investments can be costly. There are ways to manage this, but they will require asset managers to make careful business decisions alongside the purely investment decisions.
More flexibility and choice, if used wisely, enables retirement funds to construct portfolios that offer enhanced long-term, risk-adjusted returns, which can lead to meaningful improvement in long term outcomes for South African pension fund members.