No “prudent” silver bullet
According to the Regualtion 28 Explanatory Memo “[t]he aim of retirement fund investment regulation is to ensure that the savings South Africans contribute towards their retirement is [sic] invested in a prudent manner that not only protects the retirement fund member but is [sic] channeled in ways that achieve economic development and growth.”
Despite its claims, Regulation 28 does not set prudent asset limits; it merely restricts the maximum exposure to each asset class and underlying security. In this, it ignores the investment time horizon, minimum limits and diversification principles. How does this protect the retirement fund member?
Clearly, it is not prudent to hold just one asset class for any length of time (as is permitted for cash and government debt), to invest someone near retirement 75% in equities or someone just starting out 100% in cash. It is not prudent to have a high offshore weighting near retirement, given the rand’s volatile history. It may not be prudent to invest retirement savings in other African countries, in so-called frontier markets – most developed market pension funds would baulk at the idea. And it is certainly not prudent to invest 10% of savings in gold. The metal has no intrinsic value and its price is entirely dependent on investor sentiment. (Tellingly, the increased allocation comes at the end of a 10-year bull run in the gold price.)
It is one thing to impose such rules and objectives on a defined benefit plan with an indefinite time horizon where the risk is carried or insured by the employer; it is quite another to impose these in a defined contribution environment where the risk is carried entirely by the individual investor with a finite investment term. In this context, it is then highly ironic that Reg 28 does NOT apply to the Government Employees Pension Fund, the largest pension fund in the country.
In many ways, the revised asset limits mirror developments in the investment industry, in the belief that such developments signal innovation and sophistication. But alternate investments are notoriously expensive and opaque and tend to reward providers much more than investors.
Who to trust, if not the trustees?
Still, with proper in-and oversight, alternate asset classes can have a role to play. Prudent investing is a matter of individual circumstance and professional judgment; its exercise is traditionally left to individuals who have the necessary skill and experience in such matters. It cannot be based on rules, because no set of rules can be sufficiently wide to encompass all circumstances.
But Reg 28 appears skeptical that trustees are up to this task. Its “Principles” burden the fund with “the education of the board with respect to pension fund investment, governance and other related matters.” Surely the required level of education should be a prerequisite rather than an objective?
Clearly not, as the Explanatory Memo admits: “In the context of …a general lack of investment expertise among trustees, the Regulation remains primarily rule-based.” In other words, the Regulator does not believe that trustees are up to the task.
Is it prudent to permit retirement funds if their boards lack ‘investment expertise’ and therefore may not be able to interpret narrow rules to the benefit of fund members? Who should protect the interest of members, if not the trustees? Who will draft or review the investment policy statement, if not the trustees?
It is well and good delegating these tasks to service providers. But service providers do not owe fund members a fiduciary duty; in fact their interests often conflict with those of fund members. It’s asking the wolf to act as watchdog – but someone still has to watch over the wolf. But if the trustees lack the skills to direct their fund, they are equally ill-equipped to evaluate service providers do it on their behalf. Either way, members are at the risk of their trustees’ ignorance.
A government policy document
So, what is the purpose of Reg 28, if not to set prudent asset limits? In essence, Reg 28 imposes government policy on private investors.
As has historically been the case (e.g. the past requirement to invest at least 25% in bonds, to support RSA bond prices), the government is using private savings to further other objectives. Nowhere is this more evident than in the discussion accompanying the public comment process:
“The Regulation now better recognizes and promotes the responsibility of funds and boards of trustees towards sound retirement fund investment. It expands the allowance for debt issued by listed and regulated entities. This supports a stronger corporate debt market and addresses the banks structural funding mismatch between short-term borrowing and long-term lending, whilst crucially still protecting retirement funds and their member savings. The Regulator better enables investment into unlisted and alternative assets to support economic development that may be funded through capital-raising channels. Investment into Africa is likewise supported through providing for alternative ways of accessing this market in a responsible way. Importantly, the Regulation continues to better align retirement fund regulation with other government policy objectives like socially responsible investments and transformation.”
According to the Memo, increased debt exposure will reduce regulatory-induced distortions away from longer-dated debts into money-market instruments and equities; and increased foreign exposure will enable non-SA companies and foreign governments to access more SA capital and build SA as a regional financial center and Gateway to Africa. Quite inappropriately, the Memo also recommends that hedge funds and private equity funds should be accessed by way of funds, to provide an extra layer of “diversification”. Fund of funds unequivocally also provide an extra layer of fees for the industry.
It is not explained how these changes serve the interest of the retirement saver, by raising returns or reducing risk, two key objectives for any investor.
Private risk and responsibility cannot be subject to public policy objectives
The point is this: retirement investors have an obligation only to themselves and their dependents. They are not obliged to address transformation, regional development, banks’ structural funding mismatch or any other inefficiency in capital markets. These issues may well benefit from sound retirement investing, but they cannot be the objective. In the same vein, retirement investors have no duty to partake in market price discovery, as suggested by some industry representatives, only to secure an optimal outcome for their retirement investment.
Investors do not need government prescribing investment limits. They also don’t need trustees who abdicate to service providers, and who hide behind Regulation 28, complexity, investment choice and adviser recommendations.
Investors need trustees who are financially literate. They need trustees who FULLY understand their responsibility towards investors, who understand diversification, risk-appropriate investing, different assets and investment products, and the impact of cost and investment styles on the savings outcome. They need trustees who have strong, well-founded investment beliefs, and who can translate these into an investment policy statement that will help achieve investors’ retirement objectives. They need trustees who act solely in their interest.
In other words, they need professional and independent trustees.
Conclusion
Reg 28 is an exercise in contradiction. It aims to foster prudent investing, but there is nothing inherently prudent about the asset limits. It lays down rules, but requires boards to apply vague principles, this despite the “general lack of investment expertise among trustees.” It acknowledges funds must, first and foremost, act in the best interest of their members, then justifies the changes to asset limits on a host of ulterior grounds. It imposes public policy on private investors, without wishing to accept responsibility for the outcome.
If government is serious about regulating the retirement industry and the looming pension shortfall, it needs to address the needs of investor, not the policy objectives of government and industry. It needs to focus on the country’s poor savings culture, not the asset allocation.
Above all, it needs to direct the appointment of trustees, to safe-guard the best interest of investors. Who else will protect them from Reg 28?
