South African pension funds urged to make full use of their offshore diversification benefits

South African pension funds should make full use of their right to invest up to 25 percent of their assets in offshore markets to ensure diversification, and should also review their international investment portfolios more regularly.

This is the view of Giles Mokoka, Head of SEI South Africa, the local arm of the US-headquartered financial services company SEI (NASDAQ: SEIC), which specialises locally in offshore investment solutions and structuring offshore portfolios for large institutional clients. Currently, SEI has just less than $US1 billion under management offshore on behalf of major and mid-tier South African institutions, while internationally, SEI manages more than $US172 billion of investments in various parts of the world .

“Returns for pension funds have been strong in South Africa over the past 15 years, but past performance should never be considered an indicator of future performance. Offshore investment opportunities are currently showing more growth potential than the local market,” said Mokoka, stressing that the factors that have led to strong investment performance in South Africa since the mid-1990s are unlikely to be repeated over the next decade.

Mr. Mokoka identifies some of the positive factors that have driven local investment growth as: the country’s peaceful transition to democracy (and the subsequent emergence of a strong middle class); the opening up and deregulation of the economy; gold’s rise from $250 an ounce to over $1,600 an ounce; and China’s economic emergence, which has fueled demand for a wide range of metals and minerals, some of which are produced by South African resource companies.

“There can potentially be a high degree of concentration risk for pension funds that do not make full use of their ability to invest offshore and thus do not gain exposure to a wider range of investment instruments and vehicles. The top 10 listed companies (by market capitalization) constitute a staggering 50 percent weighting in our equity market at the current time, and this is dominated by resource and financial services companies,” Mokoka added, saying that metal prices are unlikely to sustain their impressive run over the next 10 years. Interestingly, most South African fund managers and investment analysts are now bullish on offshore opportunities.

Significantly, SEI believes that equity valuations now reflect South Africa’s economic potential more accurately. Thus, the room for “stellar” investment returns is more limited going forward.

Although there has not been a rush by retirement funds to increase their offshore exposures, and thereby potentially lower their concentration risk in South Africa, Mokoka is of the view that now is an ideal time for funds to re-evaluate their offshore strategies and to have an experienced and credible offshore partner acting on their behalf.

“We have seen some renewed interest in the past couple of months from our existing clients wanting to increase their offshore exposure.

“While increasing offshore investments does not guarantee superior returns to the local market, it can bring a much-needed element of diversification, and this can be viewed as good way to potentially guard against idiosyncratic risk,” said Mokoka, saying that independent research has shown that the optimal offshore asset level for local retirement funds is in the region of 30-35 percentii, a level which is, strictly speaking, unattainable under current exchange control regulations.”

Importantly, said Mokoka, pension funds also need to pay closer attention to the performance and management of their offshore assets, as they can be invested in more complex and varied environments than South Africa.

“Whereas pension fund trustees regularly review their local assets, the same level of attention is not paid to offshore assets. I speak to trustees on a regular basis, and some of them cannot recall the last time a full, in depth review and analysis of their offshore assets was undertaken, or at least when major changes were last made”, says Mokoka, who has been involved with the South African retirement-fund industry for the past 12 years.

“Even if offshore assets only account for 10 percent of a fund’s overall assets, it is vital that regular reviews are conducted into the performance, allocation, and management of these assets,” added Mokoka, who also stressed that pension funds should aim to reduce “manager risk,” which can be amplified when assets are placed with too few managers.

Mokoka illustrates this by making the point that while there are more than 22,000 investment products globallyiii, most South African retirement funds usually select two or three of the 10 or so managers who have a presence in the South African market. “This may not be the right approach, depending on the specifics of the client. For larger funds, we consider that an average of 7-12 asset managers per fund may be optimal in order to avoid the pitfalls of placing too much reliance on a single manager.”