In July 2022, the National Treasury unveiled pivotal amendments to Regulation 28, revolutionising the investment framework for South African retirement funds. Despite the regulatory endorsement for funds to invest in private markets and other asset classes, investors have hesitated to pursue these opportunities.
This hesitancy may be a result of a lack of understanding of these investments. By recognising how these changes in regulation protect members’ retirement savings, corporate SA can play a pivotal part in helping to ensure employees’ investment portfolios are optimised to ensure long term positive outcomes.
Understanding Regulation 28
Regulation 28 limits asset managers’ allocations of retirement savings to specific asset classes, including offshore assets. Here are the changes in a nutshell:
- Retirement fund investors can now invest up to 45% of their portfolio in offshore assets, fostering greater portfolio diversification opportunities.
- Up to 75% can be invested in equities (local and foreign), 25% in property, 15% in private equity, 10% in commodities, 10% in hedge funds and 2.5% in other excluded assets.
- One cannot invest more than 25% across all asset classes in one company or entity.
- One can enjoy tax advantages on retirement savings of up to 27.5% of one’s taxable income per annum (capped at R350 000). Retirement annuities are also exempt from capital gains tax on investment growth and tax on dividends and interest.
- 55% of one’s portfolio must be invested in local assets.
The valuation and liquidity concerns behind investors’ reluctance
The new regulations, effective January 2023, distinguish hedge funds from private markets, raise the investment ceiling for private markets and introduce a new limit for infrastructure investments. However, despite the regulatory green light, investors’ reluctance stems from concerns over illiquidity, pricing uncertainty and greenwashing, particularly in South Africa.
Performance and economic headwinds
In addition to the above concerns, the private market space in South Africa has also suffered from the local private equity industry not delivering the same calibre of stellar returns that attracted the interest of investors in recent years. Research from Riscura and the South African Venture Capital Association (SAVCA) has shown that for private equity funds launched since 2005, the pooled internal rate of return has not exceeded 10% to the end of 2022.
The decline in South Africa’s economic strength over that period contributed to this. From a peak of 5.6% in 2006, South Africa’s nominal GDP growth has steadily declined, with the World Bank’s current forecasts for 2024 and 2025 being 1.3% and 1.5%, respectively. This has put steady downward pressure on the valuations of South African assets, which has meant that private equity firms have faced significant headwinds to their ability to exit investments at higher valuations than they entered.
Although this spells that hard times lay ahead for the country, it may indicate a turning in the cycle for private equity funds. Prices reaching lows at the bottom of the economic cycle widen the opportunity set for private equity funds to find attractive entry points into companies demonstrating strong fundamentals and defensive strategies. Local private companies will be in dire need of funding as well as business interventions that will help them survive this challenging economic environment, paving the way for private equity funds to create value for investors as well as SMEs.
Unlocking the rewards of investing post Regulation 28
Recognising the obstacles and issues within the industry is crucial, but equally essential is acknowledging the inherent benefits they hold for investors in the form of volatility and inflation protected investments that offer attractive returns. As the market evolves, retirement funds may find these avenues increasingly attractive, balancing caution with opportunity.
Regulation 28 amendments will allow local retirement funds to increase their exposure to hedge funds and private equity and up their total infrastructure allocation to 45% of assets under management domestically, and 55% when including the rest of Africa. This change will make it easier for retirement fund trustees to approve investments into infrastructure projects that deliver economic and social impact without compromising returns.
Concerns around greenwashing can also be addressed through strict evaluation frameworks for private equity funds and their impact related goals. These frameworks should objectively quantify the direct social impact that private equity funds have on the companies they invest in as well as scrutinise the underlying activities of fund managers to ensure that dealings are above board and that information provided is a fair reflection of what is happening on the ground.
The new regulation limits how much investors can invest in assets or asset classes. However, their primary purpose is to protect the members’ retirement provision from the effects of poorly diversified investment portfolios. The regulation limits the maximum exposure for risky asset classes, ensuring investors don’t take unnecessary risks with their retirement money.
The risks which can make investors reluctant to invest in these asset classes, such as illiquidity and pricing uncertainty, also come with commensurate opportunity for reward. Through advice and guidance from an experienced partner, the risks posed by unfamiliar asset classes can be navigated in a way that opens up alternative sources of returns for retirement funds.