Economic transformation and my retirement savings – can government take it all?
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There is understandably a great deal of concern among investors in retirement funds following recent debate on prescribed assets in the press. Given that this impacts on almost every one of us to varying degrees, we attempt to look at this rationally, dispel some of the misconceptions and weigh up the risks.
What regulations are currently in place for retirement funds?
Retirement funds (Pension, Provident and Preservation Funds and Retirement Annuities (RA’s)) are governed by Regulation 28 of the Pension Funds Act. Its main purpose is to protect members’ retirement provision from the risks and negative impact of poorly diversified investment portfolios by limiting the extent to which retirement funds may invest in particular assets or asset classes. Exposure is limited to 75% in equities (SA or offshore), 25% in local or international property, 30% in foreign investments and 5% in Africa (outside SA). The 75% equity limit has been criticised, particularly for young investors with bigger risk appetites and long-term horizons. The rule, however, was introduced to protect a wide spread of investors under all market conditions.
Substantial changes have been made to this regulation over the years, but investment restrictions are nothing new as traditional pension funds have been subject to them since the 1960s. It is only since 2011 that RAs have had to comply with the same set of rules. Restrictions on more complex investments such as hedge funds or private equity have eased, and there are allowances for commodities and unlisted equity and property.
In our environment of local bond market rating downgrades, low offshore interest rates and volatile global equity markets, diversifying across asset classes globally is a responsible investment strategy and does provide the best downside protection for an individual’s hard-earned savings.
What are Prescribed Assets, and is Government considering reintroducing them?
Prior to 1988, prescribed assets forced pension funds and insurance companies to invest a large portion of assets in government and parastatal bonds.
More recently, media attention was sparked by the publication of a paper by the ANC’s Transformation Committee titled “Reconstruction, Growth and Transformation: Building a New Inclusive Economy”.
Many fear a return to prescribed assets, especially given the government’s large budget deficit and high borrowing costs. We support the broad consensus view that reintroducing this would not be in the best interests of investors or the broader economy.
So what does the ANC’s Paper propose?
The paper outlines the party’s vision for the post-Covid economy. It proposes amending Regulation 28 to allow (not force) pension funds to invest directly in infrastructure assets and development finance institutions such as the Development Bank of SA and Industrial Development Corporation.
Retirement funds would then be able to allocate their investments directly to these institutions, bypassing asset managers and possibly saving on costs. It is not clear how this would apply to unit trust-based retirement products that have a daily liquidity requirement.
What is the difference between this proposal and prescribed assets?
Fortunately, there is no indication of a return to prescribed assets, and it appears that the paper provides a more acceptable and reasonable approach.
A more viable alternative to meet government’s objectives would be to increase the efforts to make SA assets more attractive on a project basis and to generally improve the tone, structure and long-term certainty of public- private partnerships.
What process will the ANC have to follow in order to amend the Pension Funds Act?
We need to remember that the ANC’s proposals do not automatically become government policy or law. National Treasury must first consult all stakeholders including business, labour, opposition parties and ASISA (Association of Savings and Investment) before any amendments can be made to Regulation 28. This process can take years.
For those fund managers wishing to invest in good infrastructure projects, it is possible that there may already be opportunities to do so within the current regulations, through unlisted equity, immovable property, or listed and unlisted debt instruments.
If ultimately passed into law, will this policy change be unique to SA?
Globally, pension funds choose to invest in infrastructure due to its stable long-term returns. If direct investing into infrastructural and development funds is approved, this will be an additional asset class to diversify into, and these investments can still earn a decent return.
It will not become a case of the state confiscating our hard-earned retirement monies. The challenge to those parties and businesses that have been interested in investing in infrastructure and development assets has never been a shortage of funds, but rather a shortage of viable projects and a weak economy.
Should we be worried and what should we be doing in the meantime?
Retirement funds provide significant tax and estate planning benefits. Apart from contributions being fully tax deductible, all income and capital gains are tax-free. Deductible contributions and future growth are not subject to estate duty and cannot be attached by creditors.
For most people, the tax benefits alone over the course of their working life will make the difference between a comfortable retirement or becoming financially dependent on their children at some point.
At this stage, we do not believe the risks outweigh the benefits of continuing to save into retirement funds. Government is acutely aware of the low domestic household savings rate in SA. Without a stronger domestic savings pool, SA’s economic growth prospects will remain stifled and leave households and businesses vulnerable to crises such as Covid.
To address this and to reduce their reliance on foreign inflows, government needs a higher employment rate and a stronger economy. With foreign investment in SA government debt having declined to 30% (the lowest level in 8 years), the necessity to retain local and foreign investor confidence is greater than ever. A positive move in this direction was the proposal for further exchange control relaxation measures in the 2020 budget, more specifically the phasing out of the formal emigration process.
For now, there seems to be an understanding by key ministers and Treasury that prescribed assets would be a last resort. We will obviously continue to monitor any developments very closely and participate actively in discussions with the financial services industry.