It’s nearly eight years since the revised Regulation 28 of the Pension Fund Act came into effect. While pension funds have had to comply with the earlier regulations since 1962, the asset allocation limits they set out only began to apply to individual members from July 1, 2011.
Practically this meant that for the first time any investor’s individual retirement portfolio, whether it was held in a retirement annuity (RA) or a company pension fund, had to meet the Regulation 28 limits. The intention was to ensure some level of broad diversification and therefore investor protection.
Ever since the limits were introduced, however, there have been critics who believe that the restrictions could have an unintended consequence – they could reduce investors’ ability to generate inflation-beating returns.
In particular they focus on two areas: that Regulation 28 limits equity exposure to 75% of a portfolio, and that only 30% can be held offshore, with an additional 10% in the rest of Africa. (This used to be only 25% offshore and 5% in the rest of Africa, but was increased in the 2018 budget.)
Critics argue that the limit on equity exposure is most problematic for young investors. This is because those with decades to go until retirement should be investing in growth assets, and don’t really need to worry about the short-term volatility.
Restricting any portfolio to holding a maximum of 75% in listed shares, they say, is therefore an unnecessary dampener on returns.
However, this has not been the case over the last eight years. Since 2011, Regulation 28 portfolios have delivered returns very much in line with local equity funds. As the table below shows, the returns from top performers and median performers in both categories are almost identical.
|Unit trust returns: July 1, 2011 to April 30, 2019|
|SA Equity||Regulation 28|
|Top performing fund||12.53%||12.5%|
|Worst performing fund||1.77%||3.98%|
Local investors have therefore not been giving up any returns relative to pure local equity funds. In fact, the likelihood is that their ultimate experience has been better because they would have achieved those returns with far lower volatility.
That would make them less likely to switch and more likely to stay invested. Since chasing performance and changing between funds can be a substantial drag on returns, this has probably been a positive for investors.
It is also worth considering that the returns quoted above for Regulation 28-compliant funds are for unit trusts that meet the asset allocation limits. Returns within retirement funding vehicles would in practice have been higher, since they would have attracted no tax.
Only comparing returns against local equity funds is, however, not telling a complete story. Like Regulation 28-compliant unit trusts, South African equity portfolios must invest predominantly in local assets.
Over the last few years, however, the JSE has underperformed global markets in general and the US market in particular – by a substantial margin. Between July 1, 2011 and April 30, 2019, the FTSE/JSE All Share Index produced annualised growth of 11.45%, while the MSCI All Country World Index was up 19.27% per year in rand terms.
Therefore, as the below table shows, global equity funds have materially outperformed Regulation 28-compliant unit trusts. In fact, the worst-performing global equity fund returned almost as much as the top-performing Regulation 28 fund.
|Unit trust returns: July 1, 2011 to April 30, 2019|
|Global equity||Regulation 28|
|Top performing fund||22.01%||12.5%|
|Worst performing fund||11.96%||3.98%|
Looking at these numbers, it’s difficult to argue with the view that investors have not missed out. They have been unable to benefit from the growth available in international markets due to the Regulation 28 restrictions.
However, it’s unfair to take this comparison at face value. One cannot assume that any fund manager would have been prescient enough to move their portfolio 100% offshore at exactly this moment, and be brave enough to keep it there. This also would not have been particularly prudent. The extra risk and volatility associated with offshore investments would make this a less than optimal long-term strategy.
This makes the calculation a little more difficult, but if one creates three theoretical portfolios using 50% of the top-performing, median, and worst-performing local equity funds and 50% of the corresponding global equity funds, one could use these for comparative purposes. This is shown in the table below:
|Theoretical unit trust returns: July 1, 2011 to April 30, 2019|
|Blended local and global equity||Regulation 28|
|Top performing fund||17.27%||12.5%|
|Worst performing fund||6.87%||3.98%|
Source: Morningstar, Moneyweb
Although this is a far-from-perfect analysis, the median blended equity portfolio would have outperformed the best-performing Regulation 28 fund. This does suggest that investors have been denied some returns since the Regulation 28 limits were put in place.
Those returns would, however, have come with much higher volatility, and the additional currency risk that having such a large offshore holding entails. Investors would have had to accept those trade-offs.
Looking purely at performance also does not take into account that investors saving for retirement are pursuing a particular goal. The best way to reach that goal is rarely just by chasing the highest performance. Managing the risk is just as important.