BUSINESS MAVERICK/NEWS ANALYSIS
Regulation 28: hindering investors’ ability to maximise return or protection from greater downside?
Regulation 28 of the Pension Funds Act, and by extension exchange controls, has become a contentious issue in South Africa. Punted as safekeeping mechanism against risky behaviour by National Treasury, money managers say capital restrictions are disempowering their mandates and it's costing their members big time.
Local retirement rules stipulate that South African fund managers can only allocate a third of their asset pool to investment options abroad. The regulation limits equity exposure to 75% of a portfolio. In addition, there is a maximum limit of 30% in offshore assets and an additional 10% for the rest of Africa.
The country’s pension funds manage over R4-trillion in assets according to the Financial Sector Conduct Authority, and it is estimated that around 40% of the JSE is owned by these institutional investors funds and life companies.
“In that context, 30% becomes a very significant number, and has a substantial impact on inflation-beating returns,” says Suzean Haumann a Certified Financial Planner and foreign exchange consultant at Brenthurst Wealth. “Restricting the movement of capital, reduces an investors’ ability to perform better than inflation, especially at a time when the economy is under pressure and political landscape is uncertain, and saving for a rainy day becomes more important than ever.”
The sad reality is, that over the last few years, JSE equities have not kept up with inflation, while foreign assets — especially stocks — have beaten it by far, and this performance gap has grown wider over the last few years.
Over the last five years, the growth rate of the JSE All Share Index was under 7%, while the MSCI World Index returned an impressive 11.43% back to its shareholders over the same period, according to Sygnia Asset Management. Ten years ago the scenario was quite the opposite with ALSI bringing home 16% compared to the MSCI’s more pedestrian performance of 5,40%.
“If you look strictly at the last 10 years, in hindsight it is quite clear that by not having greater exposure to global assets, South African investors that have been limited to Regulation 28 investments have lost out,” says Lindsay Lofstedt, Director at Optimate Financial Solutions.
“For one, we have not been able to partake fully in the explosion of wealth created by technology companies such as Facebook, Amazon, Apple, Netflix and Google, while our foreign counterparts, especially in the US, have experienced double-digit growth rates in their portfolios being able to do so,” says Lofstedt.
Apart from the opportunity costs linked to lost returns, South Africans have also been left to their own devices and much less diversifying power than outsiders. As an emerging economy, South Africa carries a higher level of risk,” says Jonel Matthee-Ferreira, Head of Absa Multi Management.
The local market is also relatively small, with the country contributing less than 1% to world stock market capitalisation. “ The financial market is very concentrated in certain sectors,” says Matthee-Ferreira. “The market is dominated by the top five shares,” she says.
So diversification drives the ambition of local fund managers wanting more exposure to global asset portfolios, she says. Offshore equities exposure also assures protection against a very volatile rand, she says.
She does, however, warn that investing offshore is not a decision to made in isolation, and should form part of an overall strategy, with a manager with a global mandate that is able to consider all the alternatives available.
In the meantime, the outlook for South Africa remains rather dim, with GDP figures in the doldrums and company profits are under extreme pressure. According to Thompson Reuters, more than 70% of the listed Top 40 companies have disappointed on the downside to analysts’ expectations over the past 12 months.
Ironically enough, it is during these very tough times that supporters of Regulation 28 bring valuable protection against the downside of the market and smooths out lines of volatility to return.
Johan Gouws, Head of Institutional consulting at Sasfin Wealth says the biggest advantage of Regulation 28 is that it effectively facilitates diversification through its limitations in terms of geographical areas, asset classes and instruments, but also across investor emotions and behaviour.
“People are therefore not able to liquidate all their investments because of panic,” he says. “It was also this regulation that prohibited investors of putting all their money into one company like Steinhoff for example.”
He adds that the rule does not necessarily deprive investors of their long-term savings goal, which is to accumulate enough money for retirement. “Under the right circumstances, and with the regulation in place, one can manage returns of between 5-6% over the longer-term,” says Gouws.
The 30% maximum exposure to offshore stocks is not as limited as people think. He says locally listed companies derive over half of their profits from overseas, which means a 45% allocation to SA equities, effectively adds another 25% of exposure to foreign economies to South African-based portfolios. “An allocation to global entities of up to 55% is possible in a retirement funds balanced portfolio.”
Gouws admits that Regulation 28, does share traits with the exchange control regime, which aims to control the outflow of capital from the country. “Don’t assume that offshore investments will always be superior, and offer protection against currency weakness,” he says. “That is a dangerous assumption.”
The rand has been drastically volatile in the past but has also strengthened over time, which could hamper the return on foreign assets in rand terms.
Offshore prospects are not just moonshine and roses either. The global economy is facing a couple of its own challenges, which Chairman of the International Monetary Fund (IMF)Christine Lagarde refers to as a ‘delicate moment.’ The IMF cut its global growth forecast to 3.3% in 2019, largely because of temporary, country-specific factors and the tangible effects of trade tensions. At the same time, it has projected a pickup in growth in the second half of this year and a further acceleration to 3.6% in 2020, the same growth rate as in 2018.
“Our expectation was that global economic activity would also benefit from the more patient pace of monetary normalisation by the US Fed and the European Central Bank, and from increased fiscal stimulus in China,” Lagarde writes in a blog released on 7 June on the IMF website. “And indeed, these policy responses have provided vital support over the past few months, including by easing financial conditions and increasing capital flows to emerging markets.”
“In fact, the most recent economic data indicate that global growth may be stabilising—broadly as we had forecast,” she says.
So that is the good news. “Yet the road to stronger growth remains precarious,” she adds. “For one, there are question marks over the expected uptick in growth. Will the first-quarter momentum in advanced economies hold up, and will the previously projected improvements in some stressed economies materialize or take longer than expected? How would a no-deal Brexit affect confidence? And will the recent increase in oil prices further depress economic activity?”
She highlights the following concerns:
Corporate debt levels, which have increased to a point where a sudden shift in financial conditions could trigger disruptive capital outflows from emerging markets.
Economies facing disappointing medium-term growth prospects, not just because of population ageing and slow productivity, but also because of the corrosive effects of excessive economic inequality.
And most importantly the impact of the current trade tensions. The risk is that the most recent US-China tariffs could further reduce investment, productivity, and growth. The just proposed US tariffs on Mexico are also of concern.
Indeed, none of the local or foreign challenges altered the view of either camp on Regulation 28, but despite opposing views, they all agree that investors should have a well-diversified portfolio, which should definitely include a portion to offshore assets and its weighting based on the risk appetite of the investor. DM
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