Every retirement fund is served by professional trustees who are either company nominated, employee elected or are there through an umbrella fund. It’s very difficult for them to make investment decisions as so few have in-depth knowledge of markets and, therefore, must be guided by investment managers. In view of this, there are proposed changes to Regulation 28 of the Pension Fund Act, on how trustees should deal with investments.
The liability profile of retirement funds should define the investment decisions made by trustees. Consideration must be given to the long-term retirement expectation of members and ongoing liquidity required for withdrawals, pension payments and administrative costs. In matching investments with these return objectives, retirement fund portfolios could assume concentration risk. Regulation 28 of the Pension Funds Act was introduced to overcome this problem by limiting the extent of exposure to any one asset class (equities, bonds, cash and other). Further restrictions limit non-South African investments – currently at 20% of fund assets, and an additional 5% if invested in Africa.
Further sub-limits are set for the categories subject to the regulation, such as the 5% limit on unlisted shares issued within South Africa, as part of the broader overall limit for shares at 75% of total fund assets.
National Treasury has released proposals that seek to address changes in the industry since the last review undertaken in the 1990s. These focus on:
- Eliminating problems arising from discrepancies and disparities between various legislations that cross-reference each other and require alignment in their interpretation and implementation, within the context of retirement funds.
- Innovation in the utilisation of foreign investments in circumstances where the exchange control environment has altered significantly.
- The use of structured products and derivatives, not specifically catered for within the current regulation.
- Policies issued with a guarantee that have increasingly formed the basis for flagrant disregard for the regulation.
- The utilisation of Shariah Compliant investments by funds.
Further specific measures include making Regulation 28 applicable to retirement annuity funds. Credit rating agencies are given a role in that once they rate an investment, a limit kicks in relating to that specific asset as rated.
Impact of Pension Fund Act
Many commentators have called into question the need for quantitative restrictions in the first place, arguing instead for a more principles-based approach that takes into account the risk profile of the investing fund.
The draft regulation does not enunciate clear underlying principles upon which it is based. For example, in the context of life staging, asset growth may be the more important consideration for younger fund members than income generating assets, which seems retained as a bias in the proposed revision.
Those who circumvented the regulations with the utilisation of derivatives for gearing purposes, will not welcome the ‘look through’ approach and the restriction that hedging be limited to efficient portfolio management. However, it would appear that part of the debate is misplaced as it is evident that there is a lack of understanding of how derivatives are utilised currently by fund investors, and this has led to suspicion on the part of the regulator.
Private equity funds are concerned that the restrictions on their utilisation are impeding upside growth for pension funds. However, the regulatory concerns seem to be the extent to which the managers of private equity funds override the investment objectives of the retirement funds themselves, in the decision making process.
Advocates of Socially Responsible Investments (SRI) may see the reference to Islamic Shariah Compliant investments as a missed opportunity to address wider SRI issues, even though this is not an asset class, but an overlay that will increasingly become the norm in a world guided by sustainability as the watchword.
For individual retail investors, the applicability of the regulations to their retirement annuity fund, and to retirement funds where they have been accorded individual investment choice, would elicit varied responses, dependant on each individual members’ risk appetite. Fatima Vawda, CEO of 27/Four provided assistance and guidance on the complex nature of Regulation 28.