The most significant development for Retirement Funds in years?
*This content is brought to you by Corion Capital
By David Bacher*
Following the budget speech in February, the South African Reserve Bank significantly amended the offshore allocation limits for Retirement Funds. Up until this announcement, Retirement Funds were only permitted to invest up to 30% of their assets in offshore markets with an additional 10% permitted for investment in Africa. Following the latest amendment, Retirement Funds are now permitted to invest up to 45% in offshore markets. The new 45% limit is also not constrained by separate limits for Africa, thus all 45% can be invested outside the African continent.
As shown below, there has been a gradual relaxation of foreign exchange controls since 1995 with the latest change being one of the most material increases on record. Retirement Funds now have an additional 15% to invest offshore if they so choose.
Accordingly, what are the potential implications that we, at Corion, think will have the biggest effect on the local investment landscape?
Firstly, it's important to note that not all funds will be impacted equally. Some funds are designed to consume very little risk and are averse to being exposed to currency volatility. These are generally the more conservative, low equity and income focused funds.
By contrast, the funds that are focused more on long-term capital growth, which are the majority of South African funds, will be impacted significantly. We believe the five most material consequences for the local retirement savings industry are:
1. Improved Diversification
Having access to more investment options will lead to better investment outcomes. Investors will be in a better position to diversify away from South African idiosyncratic risks. They will also have greater access to companies, sectors and strategies that are not prevalent in South Africa – investments that can complement the resource dominant characteristics of the South African market. Improved diversification should, in theory, result in investors having a greater probability of meeting their long-term investment objectives.
2. Changes to a fund's strategic asset allocation and benchmarks
The first step in portfolio construction is generally, the decision on the long-term strategic asset allocation. Essentially, this is the long-term weighting to the different major asset classes that provides the greatest probability of meeting a fund's investment objectives.
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Given that the offshore restrictions have significantly changed, it is obvious that the outcome of the models previously used to decide the long-term mix of assets may no longer be valid. We suspect that many actuaries and investment professionals across the country are frantically pounding their keyboards, running new models, and seeing the degree to which a new broader investment universe will change their long-term strategic allocations to the main asset classes.
As the day follows night, so does a change in a benchmark follow a change in a fund's strategic asset allocation. This is because a benchmark is supposed to be a means of measuring a fund manager's ability to add value relative to the fund's strategic asset allocation.
3. A potential rotation out of local funds
Given the size of the retirement fund industry – estimated to be approximately five trillion rand – it is reasonable to assume around R150 billion to R300 billion of capital would leave South Africa. This is a material amount and the implications for local funds are immense. It is expected that local equity funds will be the main funder of this flow. This means that many fund managers in South Africa are likely to be net sellers of local equities over the period whilst they realign their funds.
4. Greater dispersion of investment returns
Due to most investment professionals believing that a fund focusing on long-term capital growth required at least a 30% offshore allocation, there has been very little difference between such managers' offshore allocations. Research at Corion shows that most funds in the ASISA Multi Asset High Equity Category have allocations of between 25% and 30%. In other words, they have very similar offshore exposure.
As members of local Retirement Funds live with South African inflation linked liabilities, immediately increasing offshore exposure to the new maximum 45% limit needs to be carefully considered. In addition, given the current global geopolitical developments and market volatility, and considering that South African valuations are arguably more appealing than offshore markets, it is less obvious that all managers will immediately increase their offshore exposure. This means that allocations will start to vary more between managers and funds. This will ultimately lead to a greater dispersion of investment returns within the industry.
5. The need for greater offshore capabilities
Most local fund managers that maximise their offshore allocation have built up global research capabilities or, in some instances, partnered with global providers. The increased limits may result in local managers deploying more resources to their global teams and increasing proficiency as the opportunity set broadens.
- David Bacher is the Chief Investment Officer of Corion Capital (an Authorised Financial Services Provider). Corion is driven by a desire to simplify the world of investing and manage a broad range of multi-strategy funds.
For information about Corion Capital, click here.
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