Simply put, Regulation 28 of the Pension Funds Act governs the way managers of pension funds invest in various asset classes, to safeguard workers retirement savings against risky investments.
In summary, the proposed amendments to this regulation, which was closed for public comment on 29 March 2021, provides an alternative to prescribed assets for investment as we know it, including establishing a minimum floor for a pension fund’s investment to be held in government stock, with the aim to leverage this for economic development in growth. We take a bird’s eye view of Regulation 28 as it stands, and what the proposed amendments mean for workers’ pensions, as well as for the institutional investors who must look after their retirement savings.
Overview of Regulation 28
To reduce risk and safeguard workers’ savings, retirement funds are required to invest in a diverse range of instruments and asset classes, such as equities, bonds and cash. Regulation 28 of the South African Pension Funds Act governs this by limiting the percentage that institutional investors or managers of pension funds may invest in these various instruments and asset classes as well as geographical areas. As it stands for example, institutional investors may only invest up to 30% in assets around the globe, excluding of Africa, a limitation which may sometimes actually be to the detriment of the fund.
Proposed amendments and what they
• Infrastructure
‘Infrastructure’ per se is not defined as a specific category in the current regulation, and institutional investors may obtain exposure across several instruments and assets such as bonds, equities, immovable property, private equity and other. The proposed amendment is to introduce a more precise definition of infrastructure with various limits and aggregate limits for exposure in all these instruments and asset classes already permitted through Regulation 28. This will also help to establish better parameters for the purposes of data collation and measurement. Should this come into effect, the proposed overall investment limit in infrastructure across all categories will be 45% for domestic exposure, and an additional 10% for exposure in the rest of Africa, with a 25% aggregate limit per issuer or entity.
• Split of hedge funds, private equity and other assets
The proposed amendments will split “hedge funds, private equity and any other assets” that are not listed in the current schedule into “hedge funds, private equity and any other assets not listed in the schedule” in stand-alone asset classes. This will enable the introduction of specific limits of exposure to each of these asset classes. The limits for exposure to “hedge funds and any other assets not listed in the schedule,” have remained the same as follows: Hedge funds (2.5% per hedge fund, 5% per fund of hedge funds (FoHF), with an aggregate limit of 10% for hedge funds and 2.5% for “other assets.”) As a result of the split in assets, the limit of 15% of exposure in “hedge funds, private equity and any other assets not listed in the schedule” has been removed though. The amendments do however propose a change in the limits of “private equity” exposure, as set out in the table below:
Table 1: Limits of exposure to private equity
Pros and cons
“From an investment perspective, we believe that whilst revisiting this regulation, which was last reviewed in 2011, government should have also considered revising the current limitation of 30% to global exposure (excluding the additional Africa allocation),” says Gerrit Craucamp, Head of Investment Strategy at Novare Actuaries and Consultants, a subsidiary of Novare Holdings. “The rationale being that this limitation prevents investors from taking sufficient advantage of a league of offshore investment opportunities and exposure to global industries, technology and innovations that are not available locally. This in turn counteracts some of the attempts for diversification, and prohibits investors from generating better returns.”
Craucamp explains that whilst the proposed amendments are increasing the investment limit in “private equity” and “unlisted infrastructure equity”, the draft amendment in its current form is also effectively reducing the current investment limit in “infrastructure equity” and “unlisted infrastructure debt” which could result in unintended consequences. A fund can for example currently invest 100% of its assets in “infrastructure debt”, which is guaranteed by the government, but the new proposed amendments will limit this exposure to 25%. Similarly, a fund can currently invest up to 15% of its assets in “unlisted non-guaranteed infrastructure debt”, whereas the proposed amendments will limit this exposure to 3%.
Craucamp notes that except for the points mentioned previously, the proposed amendments of Regulation 28 of the Pension Act Fund is however no doubt a positive move in the right direction, as it presents the potential to yield a win-win for both our socio-economy and investors. He explains that this approach is however by no means new in the investment space. Whilst they are illiquid, infrastructure projects indeed have the potential to provide an alternative source of competitive risk-adjusted returns for its members, especially in the current economic landscape which is marked by low-return asset classes. This is also most likely why the pension fund industry is already significantly invested in government stocks on the JSE. For example, “of the ±R1.1-trillion under management (excluding the Government Employees Pension Fund), pension funds hold ±R202bn in government stock and another R28bn in state-owned enterprises and municipalities.” It is also this very fact that was a key driver behind the launch of the first Novare SA Impact Fund. Whilst the primary goal of a private equity fund is typically to generate optimal ROI, this impact fund will have a dual primary objective, which is to generate optimal ROI and achieve positive, measurable impact on both the environment and our society, by among others, investing in critical infrastructure development projects that form part of our National Development Plan.
In conclusion
In essence, Novare supports the proposed amendments to Regulation 28 of the Pension Funds Act, but would like to appeal to institutional investors to remain focused on what matters most. “When fund managers opt to invest in infrastructure projects, the key consideration should always be whether it meets the feasibility, investment and governance criteria of the fund’s investment strategy, and whether it serves the best interest of the people whose pension savings they are managing,” Craucamp concludes.
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