PSG Asset Management

In his budget speech in February this year the Minister of Finance, Pravin Gordhan, announced changes to regulation 28 that gives effect to the section of the Pensions Fund Act which regulates the amount and extent to which a pension fund may invest in particular assets.

According to the introduction to this amendment, the aim of this regulation is to “ensure that the savings South Africans contribute towards their retirement is invested in a prudent manner that not only protects the retirement fund member, but is channelled in ways that achieve economic development and growth. To achieve this, rules governing retirement fund investment should allow for inflation-beating capital growth for younger members and inflation-matching income for older and retired members… The rules should … strike a balance between regulatory paternalism and empowering those entrusted with the management of retirement fund assets to do a due diligence and make decisions of what investments are most appropriate for their fund’s particular liability and liquidity profile.”

We’re not sure that the amendments are actually achieving this goal of striking the balance.

One small change to Regulation 28 will, in my opinion, cause suboptimal outcomes for certain retirement fund members and make these retirement funds considerably less attractive and effective to these members than they were previously. Previously, retirement funds had to comply with Regulation 28 on a fund level. The fund’s holdings had to comply with the regulation. In terms of the recent amendment, administrators of these funds now need to ensure that each member’s portion of the fund complies with the regulation. Thus individual members can now only invest a maximum of 75% of their retirement money in equities, whereas they were previously allowed to invest 100% in equities under the old Regulation 28 as long as the fund in its entirety held less than 75% in equities.

This will have severe consequences for certain classes of retirement fund members. For example a person who starts with his 40 year working career at age 21 should have (in my humble opinion) a 100% allocation to equities because his investment horizon is 40 years and he would seek maximum exposure to that asset class which has been shown over the long-term to grow in excess of inflation the most. In addition thereto, the earliest age at which this person may begin to draw down on this investment is 55 – at least some 34 years hence! Now, this person is now forced to invest in terms of Regulation 28 and can only invest a maximum of 75% in equities with the remaining 25% invested in lower yielding investments. Thus only 75% of their portfolio can be exposed to high-growing assets.

The following example will illustrate the effect:

The average equity unit trust fund in South Africa (Domestic Equity General Sector) returned 16.98% per year over the ten years to 30 April 2011, whereas the average Regulation 28 compliant unit trust fund (Domestic Asset Allocation Prudential Variable Equity sector) only returned 13.63% per year over this period. R100,000 invested in the average equity unit trust fund on 1 May 2001 would thus have grown to R479,862, but R100 000 invested in a regulation 28 compliant fund would only have grown to R358,864, leaving the member with an underperformance of the portfolio of no less than R120,998 after the ten years. If we project this variation over a 40-year period (using the same 10-year return differential) the R100,000 would grow to R53,023,047 in the equity-centric fund, but only R16,585,183 (31.28% of the equity-centric fund) in the regulation 28 fund! The difference of R36,437,864 would make a MASSIVE difference in the retiree’s golden years, I think you will agree.

My recommendation to young people starting their careers is take note of this difference in returns and to avoid restrictive retirement products as they are too conservative for your needs. Find yourself a good financial advisor and invest in a well managed unit trust or two that can invest more that 75% in equities as you will have a more comfortable retirement.

Some may say that you get a tax deduction when you invest in a retirement fund, but they forget to tell you that you are taxed at income tax rates on your pension when you retire. You will only have a tax benefit if your average tax rate is lower at retirement than during your working life. Generally declines in income cause lower average tax rates, not something that you want when you retire.