Patrick Cairns – Moneyweb 5 June 2014

In this column, Rick Briers-Danks answers a reader’s question about financial regulations.

Question: At the moment the average P/E ratio of the JSE is at 17 times. Most of the bourse appears overvalued. So why does Regulation 28 limit offshore investment of pensions to 25% when it is clear that it is way more risky to have your pension invested in South Africa and when there is more growth available outside the borders of South Africa at the same or lower levels of risk?

Surely this isn’t protecting us anymore but rather exposing us to more risk? I do also understand that the Reserve Bank has strict foreign exchange controls, which could be why they are limiting the amount that you can invest offshore. But then Regulation 28 should not be sold as “protection” against higher risk when it is actually trying to achieve other Reserve Bank objectives.

If you believe that the JSE is currently overvalued, increasing the offshore allocation is only one alternative solution to reduce risk. There is a big assumption here that offshore equity is definitely going to perform. The question we would encourage you to consider is, what if you are wrong?

To reduce your risk and remain compliant you could consider reducing your South African equity holdings and increasing your cash holdings and be ready to buy South African assets at better valuations. You could also consider buying South African equities that derive a large portion of their earnings offshore, such as MTN, British American Tobacco and SABMiller, thereby getting the offshore exposure via JSE-listed equities.

Bear in mind that increasing your offshore exposure also means increasing your currency risk. Our currency has historically been very volatile. Moving money offshore in the last few months would have cost you, with the rand strengthening and the JSE rising again. The rand can at any point give or take from you around 20%, which should be factored in to any risk measures.

You might ask whether, as the general public in South Africa investing in retirement funds, we need protecting from ourselves. We think the answer to this is unequivocally ‘yes’. There should be some sort of guideline in place.

Regulation 28 is effectively a piece of risk management legislation that attempts to ensure that no irresponsible decisions are taken when investing retirement savings. Treasury does so by limiting how much retirement funds may invest in particular assets or in particular asset classes.

It is by no means a foolproof solution, but Treasury is relying on modern portfolio theory that diversification across various assets and asset classes offers the best protection.

One can argue endlessly on the merits of the current limits on each asset class and whether these have been set optimally. You can also argue whether there is enough flexibility given to investors. But, in principle, Regulation 28 goes a long way in achieving what it sets out to achieve.

Also remember that Regulation 28 is not applicable to discretionary investments. That means that individual investors are allowed to invest 100% of their portfolios in offshore equity if they so wish.

The Sarb has greatly relaxed exchange controls over the past few years with regards discretionary investments. So we don’t believe that they are limiting offshore exposure on retirement funds to limit the outflow of funds from SA.

You could argue that Treasury should consider increasing the 25% allocation to offshore equity, but most importantly it has to consider what is the optimum across different market cycles?

We believe that asset allocation is key, and that a well-diversified portfolio managed within Regulation 28 levels will protect investors and reduce portfolio risk.

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