SA pensions equity investment allocation declines for two years
• The real returns on fixed income are unusually high by the standards of the past 50 years
Growth markets — what used to be referred to as the Third World — now merit a dedicated pensions survey from Mercer. The firm runs a duopoly with Willis Towers Watson when it comes to international pension consulting, so would have its hands full in the rich world. But it has just published an Asset Allocation Insights report on the main Third-World regions, Latin America, the Middle East, Africa and Asia.
It doesn’t have capability on the ground everywhere. In SA, for example, its strategic partner is Alexander Forbes — and to think 20 years ago Forbes had aspirations to become a global Mercer or Towers in its own right.
The interesting factor is that pension funds in the Third World have increased their exposure to fixed income from 49.3% to 50.9%. The equity allocation has fallen from 37% to 36.1%. This doesn’t seem to make sense. If time horizons are typically 40 years in a pension fund, then surely it should be able to stomach the volatility of growth assets such as listed equities and property?
Listed equities have always been the backbone of pension fund investments. Alternatives such as private equity can provide even better returns than public markets. They provide an illiquidity premium.
As funds cannot trade out of these investments on securities exchanges overnight, they usually have to give a better return to compensate for investors who are prepared to stay invested over 10 years, sometimes longer. Yet alternative investment allocations in third world-based funds have fallen from 4.6% to 4.2%.
The SA pension industry has seen a decline in its equity allocation over the past two years from 61.1% to 58.3%, but it remains an outlier in the Third World. The strong historic and economic links to the UK, where attachment to equity is also strong, helps explain this. But it is also no surprise given what a poor hedge against inflation SA fixed income has proved to be in the past. It is easier for trustees to identify with their fund’s allocation to Naspers or British American Tobacco than to their holding in the R186, which is just a jumble of numbers for most.
The fixed-income allocation in SA has nonetheless risen over the past three years from 28.7% to 33.2%, and this includes investments in SA’s still poorly developed but growing, corporate bond market. The real returns on fixed income are unusually high by the standards of the past 50 years, and pension funds can accumulate all coupons tax free. But alternatives remain a feeble allocation for local funds, up from 2.1% to 3.6% over the past two years.
This is an area in which the Government Employees Pension Fund (GEPF) should be leading by example. It has made a good investment in the Pan African Infrastructure Development Fund run by Harith Partners (the chair of Harith also chairs Arena Holdings, which owns Business Day).
But the alternative investments bought for the GEPF through the Public Investment Corporation’s Isibaya Fund seem to keep making headlines for the wrong reasons. Of course, in SA private-sector funds are almost all defined contribution, and usually give members the choice to move between portfolios at least once a month.
Such funds have a regular stream of liabilities to meet. In aggregate the industry has been shrinking as it pays out more and more to retirees (often early retirees) and the retrenched. But SA still has one of the largest pension industries in the Third World at $158bn, not far behind those in much larger economies such as India ($227bn) and Brazil ($233bn).
We can all look enviously at the Yale University Endowment Fund, which outpaces its peer group by 7.5% on average. I suppose there isn’t much else to do in Yale’s hometown, New Haven, Connecticut, a rundown industrial town. Think East London with snow. Nonetheless, it has proved that outsize returns don’t have to mean getting one up on Wall Street. Less than 5% of the endowment’s holdings are now in US stocks, and barely 10% in international shares.
It was an early proponent of hedge funds, which still make up 20% of its assets. Yet more than half of its assets are in private equity, venture capital and unlisted real estate. Yale doesn’t specify how much of this investment could be described as infrastructure, but on the broader definition much of it will be.
I am surprised that the Ramaphosa government hasn’t proposed a fact-finding mission to Yale to see how infrastructure-heavy funds can work. It is barely an hour by train from New York City. They might even enjoy it on a nice crisp February day.
But the Yale endowment is in a privileged position. It doesn’t pay pensions, nor does it contribute to the running costs of the university, which are covered by Yale’s outlandish fees. Yale can command these as it is probably the second-best university in the world after archrival Harvard, but in many faculties Yale is even better. The Yale Endowment might be asked to fund a new library occasionally. But even then a whip-round among Yale’s wealthy alumni could do the trick just as well. So it has steadily accumulated a tidy $31bn.
As a trustee of an SA defined contribution fund I know the fund cannot have too much money tied up in private equity, much less venture capital. What if the employer decides to retrench a third of the staff? Would we then have to sell our venture capital investments for 10c on the rand?
It is no surprise that most SA funds take full advantage of their 30% offshore allowance and invest predominantly in foreign equities given that the yields on the marquee global bonds remain so feeble.