As explained in previous articles, any retirement product can be thought of as a vehicle used to carry the underlying investment. The underlying investment is the actual investment in bonds, equity, cash or property that is made with the rands in your retirement product. The product can be thought of as the container the investment is held in.
Different retirement products can be differentiated by the way tax and liquidity is treated in these products as was explained in previous articles. The aim of this article will be to elaborate on the underlying investments that can be held in retirement funds and specifically focus on Regulation 28.
Regulation 28 provides limits to the investments of each asset class within any retirement product. It therefore applies to provident, pension and preservation funds as well as retirement annuities. The purpose of these limitations is to mitigate concentration risk of members, by ensuring there is appropriate diversification. It further ensures that investor’s hard-earned money is invested sensibly without too much exposure to risky assets.
As it currently stands, the regulation limits equity exposure in retirement funds to 75% whether local or offshore. Exposure to local or international property is limited to 25%. Foreign investment exposure is limited to 30%, excluding African exposure and 40% to international assets that include African exposure. There are also additional sub-limits for alternative investments and the percentage of a portfolio that can be held offshore, among others.
Retirement savings is one of the most important investments you will make and it is therefore important that this pot of cash is invested in the most optimised way. For this reason, there are many investors that believe Regulation 28 is a very important component in ensuring that funds are invested in a responsible manner, while many other South Africans believe the limits are too restrictive, especially for younger investors with a long investment horizon and consequently an increased need for risk. (As explained in previous articles, returns of long-term investments are impacted by the rate of inflation, and increasing risk is the strategy used to grow such investments above the rate of inflation. Equities are the most commonly used higher risk asset class for beating inflation in the long term.)
The argument against Regulation 28 restrictions is not only the restriction to higher risk assets, such as equity, but also to the restrictions of having exposure to offshore assets. The South African economy only represents 0.4% of the global economy, which means that the investment can’t take full advantage of the growth in the global market. Technology is an important growth sector in the global market that unfortunately is not as advanced in the South African market or economy to have the full growth impact as would international shares.
Another concern investors have with Regulation 28 is that the government is considering, what is known as “prescribed assets”, to be included to the Regulation 28 limits. In most cases prescribed assets are loans made to government institutions and state-owned enterprises (SOEs) with the goal of repaying the investor interest for their loan. Unfortunately, the government and SOEs in South Africa do not have a very good track record and investors are concerned about corruption and inefficient management of the funds which will result in unsatisfying returns. The concern is deepened by including it as a Regulation 28 limit as it means the investor of a retirement product does not have a choice of investing this portion of their funds in alternative investments that may yield higher returns.
The Government argues that prescribed assets will allow that more money is available for investment and, as a result, the interest rate they will be required to pay will be lower. This, in turn, will free up funds that the government can use for other projects and will ultimately increase the profitability of the SOE and, in the case of Government, decreases the need to increase tax rates. Provided prescribed assets are earning a return, prescribed assets will be much less detrimental than increases in tax rates at this stage. Any increase in tax rates will result in less employment and economic development, which in turn will decrease future tax collection. By using prescribed asset, the government claims it is ensuring that there are enough investments in the country to move it forward.
Although it is a controversial topic and there are many arguments for and against Regulation 28, as well as prescribed assets, it is important that the investor knows and understands the implications of these limits and why they are in place or considered.
