The proposed reform to the retirement savings industry was likely to have some significant implications on the investments landscape in South Africa, says Craig Aitchison GM of Corporate Customer Solutions at Old Mutual Corporate.
Aitchison said so far, the recently revised Regulation 28 has been the most significant legislation to affect retirement fund investments.
“Regulation 28 limits investments for various asset classes, incorporates the look through principle, requires the reporting of breaches to the FSB and also requires funds to have an Investment Policy Statement (IPS) reviewed annually. Furthermore, trustees are urged to consider responsible investing factors when making investment decisions,” said Aitchison.
According to Aitchison, reform proposals could have a direct impact on investment strategies by encouraging greater use of passive investments as a way to reduce fees, limiting the inappropriate use of smooth bonus investments, and reinforce the need to balance responsible investing with members’ best interests.
Aitchison says passive investments are a growing trend internationally. “Approximately 15% of US retirement savings is in passive investment vehicles. Furthermore, because no active investment decisions are required with passive investing, fees are reduced compared to actively managed funds,” he says.
According to Aitchison, passive investments can be simpler to manage, requiring less active oversight by Trustees. They can also be used together with actively managed investments to allow more targeted risk taking.
However, he warns that there are some challenges for passive investing in South Africa. “The SA equity market has very big exposures to resources and some very large companies, leading to concentration risk. Furthermore, Regulation 28 would restrict the degree to which a balanced mandate could be passively managed,” he says.
Additionally, Aitchison says most investments still seek the peace of mind of well known, established investment brands, rather than passive investing – especially in light of the fact that the performance of passive investments in comparison to active investments is still the subject of debate.
Currently there are no prescribed assets for retirement funds though Aitchison says that they would provide government with a steady source of funds for projects identified as having national priority.
“Historically infrastructure investments have delivered good real returns for members and tend to be a good diversification from equity and bonds,” he says.
On the other hand, assuming prescribed assets were defined as infrastructure, Aitchison warns that it is more costly to invest in infrastructure, as one has to effectively invest in and manage a portfolio of projects. Investments in infrastructure also expose investors to different kinds of risk compared to traditional market investments.
Furthermore, access to infrastructure projects for retirement funds is currently quite limited, leaving funds very few options currently.
“Liquidity can also be a problem with infrastructure investments because it is difficult to disinvest funds from an incomplete infrastructure project. In the same vein, pricing of an infrastructure investment can be difficult during its building phase. Therefore, retirement funds should be mindful that this kind of investment is much more suited to longer term investments.”
Retirement reform discussions encourage the appropriate use of smoothed bonus investments. According to Aitchison, although this is a crucial issue to be addressed, there are several benefits of smooth bonus investments.
“Smoothed bonus investments are ideal for members with a low appetite for investment losses. Members are protected from leaving their fund and crystallising investment losses and also achieve a level of capital protection. Given this protection, investors can target a more aggressive underlying investment strategy with a better chance of high returns,” he explains.
Aitchison says that the proposals around compulsory preservation are very encouraging. “Introducing preservation and annuitisation has the effect of greatly lengthening the actual investment time horizon for a member. Members can therefore take on more investment risk for longer, leading to potentially better returns over the long-term,” he says.
Additionally, according to Aitchison, having paid up members and members receiving pensions in the fund means less need for members to be invested in cash and limits the risk caused by disinvestment “Members just switch from one category to the next,” he explains.
However, members still need to be wary of the risk of their retirement savings running out. “Members are living for longer after retirement and we expect this trend to continue, so it is vital that members ensure they have enough protection against outliving their retirement savings,” he cautions.