Last week Moneyweb looked at the impact Regulation 28 may have had on investment returns since 2011. It was a very simplistic analysis, but given the JSE’s sluggish performance against other global markets over this period, it was clear that investors could have missed out on returns that were available offshore.
It would, however, be wrong to take this as conclusive evidence that there is something wrong with Regulation 28, or that it is unfair to investors. It is, after all, a backward-looking analysis over a relatively short period of time.
Investors who are saving for retirement are generally not doing so over eight years. They have much longer time horizons.
Where we’ve come from
“It’s quite easy to assume that whatever has happened over the last 10 years is what you extrapolate into the future,” says Sangeeth Sewnath, deputy MD at Investec Asset Management. “If you do that, you would say that investing more in offshore equities would result in a better outcome for investors. But if you look at a far longer period – and we have access to over 100 years of return data – South African equities have outperformed global equities in rand terms.”
One should therefore be cautious about drawing definitive conclusions from short-term figures, particularly given the South African environment.
“We’ve had the Zuma years, state capture, all the cabinet reshuffles – and this has led to negative sentiment towards South Africa and South African equities,” says Quaniet Richards, head of institutional at Nedgroup Investments. “But in 2010, was anyone saying that you should have more offshore exposure, or take all of your money outside of South Africa? Not really, because we were in a bull market on the JSE.”
While it’s undoubtedly true that recent performance has been the catalyst for a debate around the Regulation 28 limits, that doesn’t mean it doesn’t deserve consideration. As Fred White, head of balanced funds at Sanlam Investments, points out, regardless of the sentiment towards South African markets, there are key reasons why investors should want to invest offshore, but they are being restricted in their ability to do so.
Where we’re going
“The asset spreading requirements of Regulation 28 are intended to ‘diversify’ pension fund assets,” says White. “However, the limited allowable foreign exposure results in investors getting suboptimal opportunity to truly diversify.”
By being compelled to invest at least 60% of their portfolios in South Africa, local investors have to be highly exposed to the local economy. However, at different times, growth may be much stronger elsewhere.
Global business trends may also not be adequately represented on the South African stock market. The most obvious example of this is the tiny selection of tech stocks on the JSE.
“In our own lifetime, consider the incredible penetration of technology into our daily lives and into our budgets and wallets – and mirroring that, the rise in invested assets that have benefitted from the growth in tech-related shares,” says White.
“An increasing number of South Africans are making use of Amazon, Uber or Apple products, yet we can’t access the potential returns of these sectors in a free, unlimited fashion.”
One size fits …
It’s also worth remembering where Regulation 28 comes from. It was originally written to set how pension funds at an overall level could invest their assets to ensure that they were not taking on too much risk.
“Then, in one quick change, it was applied to RA [retirement annuity] funds at a member level, without any change to the rules,” says Pieter Hugo, MD of Prudential Unit Trusts. “In other words, it seems like we’re applying fund rules to individual members. This may or may not be appropriate for individuals.”
It is, of course, impossible to apply a general rule that is going to be perfectly appropriate for everyone.
“Some people, given their financial position, should probably have 60% offshore, and others in a different position should have 10%,” says Rob Spanjaard, chief investment officer at Rezco Asset Management. “But on a broad average, the 30% that Regulation 28 allows is about right.”
This is a notable acknowledgement from a fund manager who is known to be one of the most active when it comes to asset allocation in the balanced fund space. The Rezco Value Trend Fund has been among the top long-term performers in the multi-asset high equity category for many years, and its overall asset allocation has at times shifted dramatically.
In January 2016, for example, the fund had almost two thirds of its assets in cash. Very few, if any, other funds take their asset allocation to such extremes.
Spanjaard, however, says that even over the last five years he hasn’t felt overly restricted by the 30% offshore limit.
“We push up against the maximum occasionally in terms of risk asset exposure, but we think the limits are probably in about the right place,” he says.
Risk and return
It’s also vital to consider that a retirement portfolio is not simply about maximising returns. It needs to be about reaching a particular objective.
A rough rule of thumb is that for anyone to have saved enough to be able to sustainably earn an income of 70% of their final salary, they need to have generated a return of 5% above inflation over the entire period that they contributed to their retirement fund. That is below the long-term average of 7% above inflation that both local and global equities have delivered in rand terms since 1930, according to work done by Old Mutual’s MacroSolutions boutique.
This means that investors don’t need to take the risk of being fully exposed to equities, and particularly the risk of being highly exposed to offshore markets.
“The volatility of offshore asset classes is the highest because you bring in currency risk, and the rand is so volatile,” says Richards.
Some measure of balance is therefore always required. The authorities have also shown their willingness to increase the offshore limits over time. Most recently it was upped from 25% to 30%, and many people expect it will be moved further.
“Ultimately, the Regulation 28 restrictions should be relaxed over time,” Sewnath believes. “They have been relaxing them already, and that has improved the quality of the outcome that investors get, given that you have lower levels of risk for similar levels of return.”