PRESCRIBED ASSETS: Editorials: October 2019 / January 2020

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Views of the regulator

Included in the overwhelming case against prescribeds, Olano Makhubela*
argues, is the imperative that funds earn decent returns.

A lot has been said recently about the topical issue of prescribed assets in SA. It is important for all of us to appreciate that retirement funds are custodians of millions of South Africans’ retirement benefits. The term “prescribed assets” refers to a government policy which requires investors, such as retirement funds, to hold a certain amount of investments in government-specified assets; for example, bonds issued by government or state-owned enterprises. All the published reactions to the possible re-introduction of prescribed assets have argued strongly against such a move (TT July-Sept). The reasons provided include concerns around lower returns, market distortions, compromised pensioner benefits and reduced participation in retirement funds. The last concern is worth highlighting because there is nothing in SA law that compels employees to be members of retirement funds, unless an employer provides one as a condition of employment. Another concern worth raising is that prescription can weaken the disciplining mechanism embedded in a market-driven economic system. Even though not always perfect, freedom of choice is a basic tenet that all customers enjoy in SA. This includes the ability of investors to freely change their investments to adapt to changing market conditions and investment goals. The Financial Sector Conduct Authority (FSCA), as the regulator of retirement funds, deems it appropriate to weigh in on the debate. It is the FSCA’s opinion that the reasons and concerns given by the public are sound and justified. Bonds are an inevitable asset class for retirement funds, especially if the funds practice asset and risk diversification and require stable incomes. Prescription does not seem, therefore, to be of absolute necessity. Even if it were to be necessary, it seems to result in unintended consequences which might do more harm than good. History does repeat itself at times, but previous mistakes need not be repeated. SA has been down this path before. The statistics also do not seem to indicate a dire shortage of funding. In the last 17 years, retirement funds have on average held government and SOE bonds at around 20% of their total assets. For the right product and price, there should be a buyer or investor. Current RSA bonds yield good returns compared to other foreign sovereign bonds. The question, most
probably, should be whether this 20% is sufficient. Fiduciary duty The answer to this question is best left to retirement funds, and in particular to the trustees who govern and manage these funds on behalf of members. Section 7C of the Pension Funds Act imposes an explicit duty on trustees to act in the best interest of their members and the fund. But what exactly is this duty towards members? It is the duty to ensure that members’ assets are invested and managed in the best interest of the fund members, so that they can retire comfortably. This is the goal which prompted National Treasury to roll out much-needed and extensive retirement reforms in the past eight years. These reforms ensure that the member is put at the centre of every decision made by funds and their service providers.

Makhubela . . . simply not on

It is a statistical fact that SA households experience challenges when it comes to both discretionary and retirement savings. This lack of preservation means that many South Africans reach retirement age with insufficient savings. Four factors are important in order to reach one’s retirement goals:

  • Start contributing early;
  • Contribute consistently and preserve;
  • Ensure that costs are fair and reasonable, especially in a low-return environment;
  • Ensure that the savings earn a decent return.

In the absence of mandatory preservation, it becomes even more imperative that funds earn a decent return — meaning at least above-inflation adjusted returns in the long term at a reasonable cost.

Any investment decision resulting in assets being purchased at overvalued prices because of artificial demand, or which do not yield above-inflation returns or have an opportunity cost (because in the long term equities usually outperform bonds), means that the member is likely to be worse off and not have a comfortable retirement.

This also means that trustees would be failing in their fiduciary duties. Then only they can be blamed for a fund’s poor performance if they are the sole key decision makers.

This fiduciary duty is something the FSCA has a legal duty to monitor. Why is this fiduciary duty also important to the regulator?

It’s because any fettering of the trustees’ decisions has the real potential to compromise their ability to act in the best interest of fund members. This would further compromise the long-term well-being of members. Clearly, this is undesirable because it is difficult to recover from bad retirement decisions.

Funds, through their trustees, should be the ones making the decisions, difficult as they might be, on how best to constitute their portfolios based on the demographics and needs of their members and pensioners. This allows the FSCA to hold them accountable for bad decisions.

Broader society

It is also fair to say that there is no point in ensuring that workers have decent retirement benefits only for them to retire in wastelands, under or undeveloped areas, and societies plagued by extreme inequality and social-ills. As a result, society has also appealed to large drivers of capital, such as retirement funds, to contribute towards addressing these socio-economic challenges. This is not only a SA issue but a global one too.

Does this therefore suggest that prescription might be the solution to these challenges? The FSCA does not think so. Instead, the FSCA would like to continue nudging the industry into doing what is right and good for the environment and society. This responsibility falls on all who live in SA. The FSCA would also like to encourage the market to continue providing scalable projects and investable instruments.

To this end, the FSCA recently issued a guideline on Sustainable Investing to help retirement funds to comply with the law (Regulation 28) on Environment, Societal & Governance (ESG) issues. Sustainable and Impact Investing do not mean investment choices that yield sub-optimal or no returns. They still mean undertaking sound investments for a return but bearing in mind the risk and consequences of such investments on all of us.

The best results in life come with balancing various difficult objectives and realities. The ability to make such decisions freely, and to take responsibility for them, are important in supporting the principles of freedom and progress in a democratic society.

*Makhubela is the Divisional Executive for Retirement Fund Supervision at the Financial Sector Conduct Authority.