DARRYL MOODLEY: Regulation 28 — the winds of change for retirement funds

With just a few weeks until the annual retirement industry research report, the Sanlam Benchmark Survey, is released, we anticipate that views from respondents will indicate broad acceptance of the revised offshore limits announced by the Treasury in February, albeit to a varying extent.

The offshore exposure limit has been harmonised for SA institutional investors such as retirement funds, to enable up to 45% of their assets to be invested offshore. For retirement funds, this represents an increase on the previous limit of 30%; however, the additional 10% African allowance has fallen away for investment purposes.

Benefits

The implications of these changes are wide-reaching and must be carefully considered. A more relaxed exchange-control regime for investors has long been called for, as philosophically, any exposure restrictions reduce the degrees of freedom and investment choices available to investors. While there is an argument that SA-based investors should have most of their assets invested in the rand-based SA market to minimise risks associated with a volatile currency, SA represents a small percentage of the global universe of investment opportunities. And as the pace of the delistings we are witnessing on the JSE intensifies, the local market may soon face an existential crisis.

Being a commodity-based and consumption economy, SA exchanges do not necessarily offer investors sufficient exposure to many prevailing investment trends. Global technology, healthcare and biotechnology are just some of the sectors that remain underrepresented in SA. One really needs to invest outside our borders to access these types of investment opportunities. The wider limits should therefore afford institutional investors greater access to the window of global opportunities, which can ultimately improve the investment returns earned.

However, it is significant that the extent to which the 45% allowance may be used depends on the risk budget and return targets of the specific investor or investment portfolios.

Potential adverse effects

However, it is also prudent to reflect on the potential downside for investors and the economy. The rand, being one of the most liquid emerging-market currencies available, is also one of the world’s most volatile currencies. If an investor does invest offshore it means there is potentially more exposure to currency risk in a portfolio. So, the increased 45% exposure limit may result in a higher level of currency risk borne by investors who opt to use that freedom.

For most South Africans our liabilities are predominantly denominated in rand so over time, investors should want to reduce their mismatch risk and opt to invest most of their assets in the same currency. This is especially crucial for retirement fund members who don’t plan on emigrating upon retirement. That should somewhat constrain the extent of assets they should be investing offshore.

The other consideration is that according to Regulation 28, up to 75% of a portfolio can be invested in equities. This is usually split across global and SA equities, for the reasons previously mentioned. But if we look at the SA equity market, the biggest counters or shares in the market are multinationals. Those are essentially already global companies with significant offshore revenue streams. So by considering the previous 30% offshore exposure limit and the actual “lookthrough” offshore exposure of JSE-listed companies, it is probable that up to 80% of a retirement fund’s assets are already global. That’s great from a diversification perspective, but arguably raises the question of whether the increased limit adds much value.

The change also poses a threat to the local asset management industry, as many of the assets invested offshore will probably be outsourced to international asset managers. Depending on the extent to which local asset managers can adapt, the effect of this structural change will only be known in years to come.

Indeed, this may only compound the problems afflicting SA’s struggling economy, which have been well documented. Over time the investment returns earned in the local economy will be anchored by SA’s stagnant economic growth, and the externalisation of investment funds due to the increased 45% limit will no doubt exert further pressure on JSE prices and the rand. Given that SA is a small contributor to global growth, this view could be dwarfed by global macroeconomic policy and events.

In summary, we expect that the industry has broadly welcomed the increased offshore allowance, and on balance believe the benefits will outweigh the potential adverse effects. The  Benchmark research will be released on June 14 and is likely to add some fascinating insights from the asset consultants, retirement fund members, trustees and principal officers who have been polled for more than four decades.

• Moodley is head of tailored investments at Sanlam.