Sensible offshore strategies reined in by regulation and asset managers’ onshore bias
The recent noise about prescribed assets has brought regulatory restrictions on where retirement savers are allowed to invest back into the spotlight. It would appear that a growing number of asset managers and financial advisers are realising that being overweight local assets restricts them in structuring optimal portfolios, regardless of the risk appetites and desired financial outcomes of their clients and investors. Magnus Heystek, a director at Brenthurst Wealth Management, has been outspoken on the need to diversify assets offshore as far back as 2011.
Go offshore, or die back home
In a recent piece ominously titled ‘If you do not go offshore, you are dead’ he observed: “I have been recommending offshore investments long before it became fashionable”. The headline, it turns out, was borrowed from a warning given during a recent investor presentation by Thys du Toit, one of the founders of Coronation Asset Management and now head of an offshore fund called Rootstock Investments. Heystek wrote that he initially turned to offshore equity opportunities to expose local investors to sectors of the global economy that were not available through the domestic markets. The JSE, which has seen its universe of listed firms shrink over the years, does not offer anywhere near the diversity available on US indices such as the NASDAQ and S&P 500.
His motivation to move clients’ funds offshore changed around 2015. At that time, observed Heystek, it became necessary to offer clients protection against South Africa’s deteriorating macroeconomic and socio-political situations. FAnews readers know the story all too well, having experienced first-hand the damage caused by rampant corruption and mismanagement in every sphere of government, from local municipalities, to national departments, and extending to myriad state-owned entities (SOEs). But asset managers’ ongoing bias towards onshore investments, coupled with the regulatory restrictions contained in Regulation 28, have meant that many retirement savers are forced to take heavy exposure to South Africa Inc.
Heystek, who claims to have weathered a storm of criticism for his pro-offshore views, wrote that many of his peers continue punting local investments despite a decade of subpar returns. “Most asset managers kept on trying to stem the [poor return] tide by assuring investors that the short term underperformance [of local asset classes] will soon turn around, and that it is not a good time to cut and run,” he said. The result has been a decimation of South Africa’s retirement fund savings on an unprecedented scale. A look at local versus offshore equity returns, based on a comparison of the JSE All Share Index to the MSCI World Index, confirms an offshore ‘clean sweep’ over one, three, five, and 10 years. And it matters not whether you measure the performance in rand or US dollar.
Jane Average does not have 100 years
Sticking with the asset managers’ convention to ‘remain invested for the long term’ we compare the 10-year returns, in rand, from the ALSI versus the MSCI World as 9.1% per annum versus 17.2% per annum. Measured in dollars we get -0.04% per annum from the ALSI versus 6.9% per annum from the MSCI World. Comparisons to the US-based NASDAQ or S&P 500 would leave South African investors feeling even worse. Many asset managers, somehow ignoring this damning evidence, use their quarterly fund presentations to convince financial advisers to remain upbeat about local asset classes. “It is foolhardy and bordering on dishonesty to suggest that the local market is cheap, undervalued, and the best investment opportunity amongst emerging markets, as local fund managers tend to do at their presentations,” opined Heystek.
There are two major themes impacting investors and retirement savers alike. The first is that the local investible universe comprises just 344 firms. If one removes Naspers from the list, you find that the JSE’s entire market capitalisation is smaller than each of a handful of US-listed giants. Second, retirement savers are restricted in their exposure to various asset classes, domestically and offshore, by Regulation 28. Bruce Cameron, who writes a guest column for Daily Maverick, has joined the throng of consumer journalists who suggest that savers should remedy shortcomings in their retirement fund performances by saving more. In a piece published 14 August 2020 he writes: “Short and longer term budgets are the underlying key to every financial challenge you have”.
We agree that a focus on your money matters is imperative; but Joe and Jane Average should be able to complete this process confident in the fact that the amount they divert towards their retirement savings delivers to its full return potential. If the returns generated by this money are hamstrung by regulation, such as Regulation 28, or asset managers with a domestic bias, then they are on the proverbial hiding to nothing. And prescribed assets will only make matters worse.
Value decimation under prescribed assets
An Alexander Forbes presentation focusing on the role of alternative developmental investments in the South African economy set out the value decimation caused by the country’s previous flirtation with the prescribed assets construct. They noted that the requirement for retirement funds to invest in government and SOE bonds through the 1960s, 1970s, and 1980s resulted in significant return underperformance. If Alexander Forbes has its way, then prescribed assets will be abandoned in favour of changes to Regulation 28 minimums to allow for more funds to be invested in so-called private markets.
“Private markets as an asset class is somewhat similar to the traditional asset space in its underlying composition; the overriding difference is that private market assets do not trade on listed exchanges,” said David Moore, head of alternative investments at Alexander Forbes. In the absence of an exchange to facilitate the buying and selling of these assets, they tend to be illiquid. Moore introduced the private market asset class under the sub-headings private market equity, including traditional private equity and speculative venture capital opportunities; agriculture, including all businesses in the broader agriculture value chain; private property; private debt; and infrastructure. Our concern is that the firm’s solution to prescribed assets does little to address the onshore versus offshore dilemma.
Asset managers will have to consider a range of factors for success in the private markets universe, including managing illiquidity; accommodating the 10-15 year investment time horizon; and the choice of investment partners who excel in private market portfolio construction. “The legal and tax aspects surrounding these portfolios is also quite complicated,” said Moore. What does the future hold? Is it possible that government will abandon prescribed assets in favour of greater flexibility under Regulation 28? Alexander Forbes believes that prescribed assets fly in the face of stakeholders’ fiduciary duties and the need to secure sustainable return outcomes for retirement fund members.
The offshore debate remains unanswered
“Our main message, which we have been putting out very strongly, is to make [prescription] voluntary,” concluded Janina Slawski, head of investments consulting at Alexander Forbes, presenting alongside Moore. “The more voluntary the investments are, the more creative the investment structuring can be, and [the easier it will be] to safeguard pensioner and members benefits”. The debate around whether increased exposure to private markets can address the local versus offshore return dilemma will have to wait for another day.
Writer’s thoughts:
One of the arguments held up for making local assets a core component of a retirement saver’s portfolio is that they will spend these assets domestically through retirement. It seems absurd, however, that you would pass up the best possible returns by hunkering down in the JSE at a time when global markets are surging. What are your views on the local versus offshore debate? And do you agree that the issue is more problematic for retirements savings than discretionary investments? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].
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