Earlier this year, the ANC’s Economic Transformation Committee published a proposal outlining changes to Regulation 28 of the Pension Funds Act. Regulation 28, which controls the extent to which retirement funds may invest in particular asset classes. This is intended to ensure that members’ retirement annuities are protected from poorly diversified investments.
Currently, the regulations require that no more than 15% of member benefits are invested in alternative investments including hedge funds, private equity and unlisted property and limits investments in equities to 75%, offshore exposure to 30% and listed property to 25%.
The proposed amendments are intended to allow investment managers to invest a percentage of their funds in public infrastructure, an investment which under the existing regulation is not directly permitted.
As the South African economy continues to be battered by the impact of the Covid-19 pandemic and subsequent lockdown, government has stated its intention of putting infrastructure investment at the heart of the country’s economic recovery. Investments in infrastructure have traditionally acted as a kick-start to lethargic economic growth by creating jobs and attracting investment.
The government’s challenge, however, is that it has little fiscal space in which to fund infrastructure development, hence the move to utilise retirement funds and savings to bridge this gap.
Finance Minister Tito Mboweni was expected to make an announcement around Regulation 28 in his June emergency budget speech. However, the announcement was pulled from his speech at the last minute.
While the idea of prescribed assets has always been a concern, the ANC’s head of economic transformation – and chair of the Development Bank of Southern Africa (DBSA) - was recently quoted as saying the ANC is not proposing a policy of prescribed assets but rather a relook into regulation 28. He also revealed that the ANC had had talks with the South Africa’s top 20 pension funds, including the Public Investment Corporation – which manages the Government Employees Pension Fund – around amending Regulation 28.
Trade union Cosatu has said it agrees in principle with amending the regulation on condition that there is a balance between investing in high risk speculative assets and in developmental projects given that the latter is more likely to provide guaranteed returns in the long term.
However, after several years of significant and systemic corruption and the diabolical state of state owned enterprises there is little confidence in the ability of the state to drive any degree of economic recovery through a state led approach. This, coupled with a lack of bankable infrastructural projects and poor implementation of infrastructure projects has over time dissuaded greater investment into this sector. Whether government’s new Investment Infrastructure Office is able to resolve these issues remains to be seen. Nevertheless, given how poorly government has managed the fiscus to date South Africans should be vehemently opposed to any form of prescription.
Andrew Duvenage, managing director of NFB Private Wealth Management responds to frequently asked questions around the current retirement legislation, the proposed amendments and what this means for retirement savers.
Q: As the South African economy continues to falter and given the limits of Regulation 28, is it worth hanging on to pension funds or should members cash in as soon as possible and move their money offshore?
Andrew Duvenage: One of the major constraints for pension fund investors is the limitation around international diversification. Under normal circumstances, investors should be looking to have significant weightings towards global investments in order to protect themselves against a further deterioration of the local economy, as well as to give them exposure outside of the relatively concentrated nature of the South African equity market. If investors are unable to achieve this diversification due to a significant exposure to pension funds, it may be worth - where possible - to consider exiting such investments in order to achieve this diversification.
There are various mechanisms that could be utilised to achieve this including withdrawing investments from preservation funds (bearing in mind that this withdrawal is subject to taxation); retiring from retirement annuities, pension and provident funds in favour of living annuities where Regulation 28 does not apply; and withdrawing the maximum allowable cash amounts (currently one-third of retirement annuities and pension funds, and 100% of provident funds is permissible).
This is not an easy decision to make and can come with significant tax and retirement planning consequences. So, while it is not possible to give blanket advice on the issue, investors should be considering their overall asset allocation, and whether the constraints associated with retirement funds are manageable in this context.
Q: What are the benefits of saving in a pension fund?
Andrew Duvenage: Pension funds offer some tax advantages in terms of deductibility of their contributions, and the tax and estate duty free profile of the investments. What is important to bear in mind, however, is that while contributions are tax deductible to a point, the income drawn from retirement funds – once they are converted into living annuities - is fully taxable. In addition, there are tax implications on withdrawals from retirement funds when converting into living annuities. Thus while there are short term tax advantages associated with retirement funds, there are longer term tax considerations that are sometimes not factored into the discussion around the tax benefits of retirement funds.
Q: What are the implications of an amended Regulation 28 on retirement savers money?
Andrew Duvenage: The most significant implication of an amended Regulation 28 is that it potentially compromises freedom of choice. The funds investors could be forced – or politically pressured - to invest in could be projects or assets that they would not normally invest in based on sound investment principles, but are instead based on Government’s needs. The bottom line is that Government has failed to effectively manage the fiscus with the result that they are now looking to savers to bail them out. Investors could therefore be forced into sub optimal investments, reducing their returns over time, increasing risk in their portfolios, and ultimately compromising their retirement savings.
Q: Is it a good idea to put all your retirement savings into a retirement vehicle?
Andrew Duvenage: We don’t believe investors should put all of their investments into retirement funds. Not only do retirement funds come with significant liquidity constraints, but the limitations imposed on them in terms of asset allocation choice can be a fundamental impediment to building a diversified portfolio. Discretionary assets are essential to address these two issues.
Q: How safe would investments into public infrastructure be?
Andrew Duvenage: The details of what these projects would be, how they would be structured and what safeguards are in place are unclear. However, the track record around state owned enterprises, delivery on material infrastructure projects in recent years, and the general lack of accountability and blatant corruption associated with state led projects, indicates that there is significant risk. It’s difficult to ignore the evidence given the current state of the fiscus and the poor state of state owned enterprises. The reality is that had the fiscus been well managed, prescription of assets would not be required, as investors would in theory invest in such projects based on their merits.
Q: How can I hedge my retirement savings against a depreciating ZAR?
Andrew Duvenage: The options are limited in that offshore exposure is limited to 30%. In addition to this 30%, investors could try to select funds that have high weightings to rand hedge stocks and assets within the local component of the fund.