AMRI founder, Muitheri Wahome, ponders the steps retirement fund trustees should be considering right now.
Many retirement fund boards of trustees are in the throes of revisiting or reviewing their fund asset allocation strategies as regulatory changes have increased institutional investment limits, allowing significantly higher investment offshore (45%), alternatives [private equity (15%), hedge funds (10%), other alternatives (2.5%)] and infrastructure themed investments (45%).
A high inflationary environment, rising interest rates and the looming threat of worldwide recession is whiplashing global stock and bond markets, upending the diversification benefits of the traditional balanced portfolio.
As if that is not enough, a higher allocation to listed infrastructure, private equity and global equity will effectively reduce the slice allocated in growth portfolios to South African-listed equities. Asset allocation skills to address the offshore-onshore asset allocation decision are going to be highly sought-after.
Asking the right questions
- In the wake of these seismic changes, trustees are asking and need to contemplate many fundamental and weighty fund policy and implementation questions, such as:
- What areas should we focus on to ensure a better future for our members?
- How do we devise strategies focused on capital preservation and the need to maximise returns for members?
- What are prudent and appropriate allocations to infrastructure, offshore investments, and alternative investments?
- How do we select active managers when manager selection is so hardHow do we face up to the changing set of risks beyond the typical investment horizon, e.g., the financial risks of climate change, the impact of a decarbonising world on existing assets and the risk of re-pricing of other assets?
- What are the potential (un)intended consequences of these global trends on long-term performance?
- What is the role of retirement fund savings in SA’s success?
Certain risks will grow in importance in this new investment landscape. With private assets on the rise, managing liquidity risk will need greater attention but could become easier to manage under the proposed two-pot system, which will limit access to savings pre-retirement, boosting retirement outcomes. Private market fees are higher than those of listed SA equities and are complex to calculate and monitor. A higher allocation offshore adds to the currency risk and fees. This raises several questions: should investors hedge their currency risks in the short-term? How are currency hedges priced currently and what determines the cost of hedging? Does the cost of hedging justify the benefit, long-term?
Trustees have a fiduciary duty to put the best interests of members first. Increased competition from foreign firms targeting the global fund allocation might be good, particularly if it results in more opportunities to invest for growth and improve diversification at a lower cost.
The landscape has changed
It is important to ensure that great homegrown asset management businesses with institutional market value propositions that are well supported by local and global expertise (whether that expertise is in-house or outsourced or through partnerships with foreign firms) have a fair shot at managing offshore assets. Anecdotally, however, market sentiment is that this is not universally the case.
In the past, when the offshore allocation was low, clients mainly placed assets with SA managers in global balanced funds because it was easy to do, and they were familiar with the brands. Not anymore.
Today, what matters most to clients has changed.
The differentiators that matter most to clients are investment performance, client service, transparency of fees and charges and transformation that is tangible. In addition, advisors want customised offerings for local needs and easy access to client specialists, data, and client insights for better asset allocation decisions.
Advisors and platforms have an important due diligence role to play in identifying areas of sustainable competitive advantage, including firm culture, the clarity of investment approach, and quality of investment research when selecting managers. Judging asset management skills is hard to do locally, let alone on a global scale, but it can be done. Among other questions, retirement fund trustees should ask their advisors how they identify talent, what types of firms they are pursuing, whether they have a team that can execute, and how they stay in touch with the firms to keep abreast of changes etc.
So how can trustees navigate volatile and uncertain capital markets and geopolitical environments and discharge their fiduciary duty? By focusing on improving the quality of their processes, diversifying portfolios, and being clear about what gives their asset managers’ an investment edge. And finally, by learning and documenting their decisions for those that come after them.
Focus of improving the quality of processes
Investment outcomes are always highly correlated with quality of the process. A quality process that is transparent and explicable to anchor the most important decisions is crucial. While a sound decision-making process may not always translate into a good outcome in the short-term, it provides the basis for long-term success and a better way to understand and interrogate outcomes. In a complex and time-constrained world, with many things competing for your attention, take time to identify the most important questions to focus the board’s attention, and remember, in the words of Eugène Ionesco, “it is not the answer that enlightens but the question.”
Second, ensure your portfolio is sufficiently diversified to cope with an inflationary low-growth environment and that you incorporate risk and return considerations as you take advantage of the new opportunities. Opportunities to invest for growth, to improve diversification and to express values through sustainable investing, including Environmental, Social and Governance (ESG) will be critical.
Third, be clear about your asset managers’ investment edge – their experience and personalities provide clues to how they might behave in tough times. A good understanding of their skills, which environments favour their investment approach, and how they complement the existing manager-blend engenders confidence, and helps you stay the course and not make expensive hiring or firing mistakes.
Lastly, learn from your experience. History shows that the competitive health of the industry is not only shaped by government policy through regulation but by the collective actions of investors, new competition, and advisors guiding their clients’ investment strategy, asset allocation and investment mandate decisions.
Muitheri Wahome is the founder and CEO of Asset Management Research Institute (AMRI) and the author of Building Capital – A History of Asset Management in South Africa.