Pension changes to protect savers could backfire – Imara

Recent changes to Pension Fund legislation intended to protect savers might have the opposite effect on workers in the under-30 age bracket.

This alert has been sounded by Imara Asset Management South Africa, an investment company that advises many salary-earners on financial planning and the need to augment company-driven retirement provision through personal saving instruments like retirement annuities (RAs).

Regulation 28 of the Act was amended in February, requiring adherence at individual member level rather than overall fund level. The regulation specifies maximum asset allocation limits for pension-funding investments.

One provision limits equity exposure to 75%, property exposure to 25% and foreign exposure to 25%. Previously, these restrictions were applied across a fund.

To give one example, this meant that people planning to retire overseas could hold 100% of their assets offshore as long as the total fund of all member assets met Regulation 28 requirements.

“The intention of the change appears to be to protect pension fund members by controlling exposure to perceived higher risk asset classes like equities and offshore assets,” says Lara Warburton, managing director of Imara Asset Management SA.

“The authorities should be applauded for steps to protect fund members, but these measures could backfire in the case of young employees with perhaps 35 years to go before retirement.”

Warburton acknowledges that share markets have become increasingly volatile, especially measured over short periods of time. However, in the long term equities have the best record of inflation-beating returns and a proven capacity to build personal wealth – so much so that some young clients saving for retirement are advised to make a 100% commitment to equities.

She explains: “Perhaps no significant under-performance will result from a 25% portfolio allocation into cash and bonds for fund members over 45. But why would a 28-year-old with a 35-year investment horizon want to make a big commitment into bonds – especially right now?

“A 75% equity ceiling makes little sense in a case like this. A larger equity commitment is often recommended as younger savers have enough time to recover from cyclical market corrections.

“The individual ceiling envisaged by Regulation 28 could put a brake on upside without significantly improving investor protection as time in the market over a 35-year period normally provides built-in protection.”

Warburton suggests the authorities monitor the long-term impact of the regulatory change; specifically the effect on a savings product like RAs.

“The RA’s attraction as a supplementary savings tool could be affected,” says Warburton. “Young clients may decide that as RAs carry an equity limit they should examine other options, notwithstanding an RA’s tax advantages.

“Many alternatives to the RA, like unit trusts, are easily accessible. The danger is that young people may ‘raid’ their supplementary saving plans to buy lifestyle assets rather than commit to long-term saving.

“The net effect would be diametrically opposed to the regulator’s intentions. Only 6% of South Africans make sufficient provision to enable a reasonable retirement. It would be a tragedy in a low-savings economy like ours if regulatory change made it even harder to achieve this goal.”