Many of us fear that in an effort to bail-out Eskom and contain the national deficit, the Finance Minister will announce a prescribed asset policy for retirement funds in his 2020 Budget Speech. If implemented, this would force pension fund managers to place a portion of the assets under their care into specific investments, likely to be State Owned Entities (SOEs). Retirement savings need to be handled carefully so naturally there’s resistance, since SOEs have performed poorly and irregular expenditure remains a problem. But before you cash-in your retirement savings early to avoid lending money to Eskom, we want to provide some clarity on the issue, because a hasty decision can erode your wealth faster than any government mandate.
How retirement funds work: defined contribution vs defined benefit funds
When it comes to retirement savings, National Treasury sets rules for how and where fund managers can invest. For example, Regulation 28 of the Pension Funds Act already dictates that a maximum amount of 30% can be invested in offshore assets, with an additional 10% allowed for rest of Africa investments. There are also maximums on equity (75%) and property allocations (25%).
These rules exist as guidelines to ensure that retirement funds are managed prudently so that the State limit’s it’s burden of retirees who can’t provide for their own retirement. Most South African’s save for retirement in a defined contribution environment, which means we can only take out what we’ve put in (including growth on your investment). There is no obligation for an employer or the State to take care of you in retirement. It’s up to you to ensure you’ve saved enough to take care of yourself. Because of this, how the savings are invested and managed becomes extremely important. Defined Contribution retirement capital is solely a factor of the compound investment returns over one’s lifetime of saving.
By contrast, the Government Employees Pensions Fund (GEPF) scheme is a defined benefit fund. In this instance, the fund is obliged to provide a defined retirement pension benefit for it’s members, regardless of investment performance or returns of the underlying investment portfolio. A defined benefit pension is based on based on your working salary and years of service. Whatever the retirement fund’s performance, your employer has to pay what’s committed to you.
Because the GEPF is a defined benefit fund, pensioners are paid out regardless of how their combined capital performs. If performance is poor, then that funding gap becomes the burden of the Government. Since investment returns don’t directly impact on members of a defined benefit fund as much as they do in a defined contribution fund, the relevance of prescribed asset allocation for retirement funds really has the greatest impact on defined contribution funds.
Three reasons NOT to be concerned about prescribed assets right now
- It’s in government’s interest to preserve your savings
The whole of point of a defined contribution environment is to reduce the state’s burden by making people manage their own retirement savings. It’s therefore in government’s interest that your investments perform so you can provide for yourself and continue to fund the fiscus and grow the economy. It is likewise in government’s interest too that the GEPF (regardless of being a defined benefit fund) perform well, because then it can fund its retirement obligations to government employees without needing additional resources. Investment returns are relevant.
- Government is currently comfortably raising debt
Around 12% (around R500 billion) of South Africa’s total pension assets are already invested in government bonds. South Africa’s current credit rating concerns have not impacted on the government’s ability to raise debt. Government is currently raising approximately R4.5 billion in debt each week through local and global debt markets, so it doesn’t need to force people to lend it money.
- A prescribed asset allocation would probably take years to become law
Even if prescribed asset allocations went ahead, it would take many years for it to pass. History shows that it takes years and sometimes more than a decade for an issue tabled at the ANC’s national policy conference to become law. And even if that happened, buying government bonds which are rated below investment grade has an attractive risk cost and performance benefit – better than depositing money in a long term fixed deposit with a bank such as FirstRand or Standard Bank. From a risk perspective, that’s because once a country’s sovereign credit rating is set, no corporation or parastatal can have a better rating than its government. And from a performance perspective, South Africa’s bond market yields are making good returns for investors.
Be cautious in how you respond to the Budget Speech later this month. Taking action on misinformation or perception will destroy your efforts to create long term real wealth. Remember: retirement savings are only tax-free while they’re invested. As soon as they’re taken out, there’s an after-tax obligation to be paid, which can destroy wealth prematurely and unnecessarily.
Andries Kotzee is the Chief Investment Officer at Celerity Investments.
Ricardo Teixeira is the Chief Operating Officer at BDO Wealth Advisers.
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