Can a Regulation 28 compliant fund shelter retirement savings from the South African economy?

A Regulation 28 compliant fund allows you to deduct your retirement savings contributions from your taxable income. While the structure is tax efficient, investors must be confident that the returns generated from their chosen fund are considerably above the rate of inflation to sustain a comfortable retirement. 

With a multitude of options to choose from, which fund should you select and why? With or without a financial advisor, the fund selection process can be overwhelming with several factors to consider, such as past performance, fees, track record and fund size. One of the most impactful but overlooked factors relates to the geographies in which the investments generate their revenue. Regulation 28 compliant funds are permitted to allocate up to 45% to offshore investments, previously 35%, but is there a way to maximise this further? Many funds do not deviate significantly from their benchmark and ultimately underperform once fees have been deducted. High Street Asset Management differentiates itself by employing an extreme offshore bias by taking full advantage of the 45% offshore allocation and, then, selecting locally-listed stocks with significant foreign revenue streams.

Stock markets can be highly unpredictable and the price which investors pay for a share can deviate significantly from the company’s fair value. However, over longer periods, the picture becomes clearer, with share prices reflecting the company’s cash-generating ability. Most businesses and their ability to produce profits are highly susceptible to the economy in which they operate. From 1995-2023, South Africa (SA) produced a satisfactory annual economic growth rate of 2.4%, which equalled that of the United States (US) over the same period.

Consequently, the local equity market (JSE All Share Total Return Index) accounted for this growth and has risen by 12% per year, including dividends. This annual return is over 6% ahead of inflation and would be considered acceptable for most retirement savers. The chart below shows the total returns, both in Rands, of the local market against the major equity market in the US (S&P 500 Total Return Index) shortly after attaining democracy in 1994.

Until recently, the local market had outperformed the US equity market; a notable achievement given the US has been a difficult benchmark to beat. Buoyed by surging commodity prices, the SA market was amongst the top-performing markets in the world over a sustained period. However, over the past decade, local economic growth has slowed to just 1% per year and diverged from the sustained growth seen in the US.

Not surprisingly, the divergence in economic fortunes has been mirrored in the financial markets with the US outperforming the local market by a staggering 339%! Many of the issues that have caused this dislocation, from corruption to ongoing load shedding, have been well documented.

Two of the largest locally-listed companies, Naspers/Prosus and Richemont, derive almost all their income from offshore operations and their share prices have increased sharply over the last decade. They account for a significant portion of the local market and have been responsible for lifting the index’s performance. Despite the SA market significantly underperforming the US, if one were to remove these two behemoths from the index, the performance looks considerably worse. 

Recent poor performance can be attributed to locally-focused SA companies who are largely dependent on the local economy to support revenue growth. The extent of this extreme underperformance can be illustrated by the recent performance of the largest companies within sectors that are notoriously sensitive to the local economy. The figures below reflect the difficult operating environment that these companies have endured over the past five years as the economy has stalled. When converting the Rand returns into US Dollars, the value destruction in global terms becomes apparent.

Some market participants believe that the decline in share prices of locally-focused companies fail to reflect the company's prospects and their share prices are set to rise following years of stagnation. Others are of the opinion that the current share prices accurately reflect the local environment and the economic outlook does not justify a recovery of any nature. Depending on a retirement saver’s stance on the matter, one should consider their fund’s offshore allocation and its vulnerability to the Rand exchange rate. 

Many funds cater for a local recovery but few cater for retirement savers who want to maximise offshore exposure. High Street applies its mandate consistently and will always aim to deliver a fund with a 90%+ offshore bias while remaining compliant with retirement regulation. For retirement savers who believe that offshore markets will continue to outperform the South African market over the long term, you might wish to consider the fund’s unique and enhanced offshore bias.

High Street Asset Management is an offshore and Rand-hedge investment specialist managing a retirement compliant fund that maximises offshore exposure and minimises local risks. It has a track record of strong performance during bouts of Rand weakness. For more information, see www.hsam.co.za. DM