Cape Town - If you are new to the world of investing, Regulation 28 of the Pension Funds Act imposes limitations on the extent to which a retirement fund can invest in particular asset classes such as equities, bonds, property and cash. It also places limitations on the amount of the fund’s assets that can be exposed to foreign markets.
For the average retail investor this means you can only invest in a fund that has a maximum of 75% invested in equities, 25% in property while no more than 25% of the fund’s assets can be invested offshore (although an extra 5% can be invested in Africa). These restrictions apply to all retirement funds, pension schemes, provident and preservation funds as well as retirement annuities.
The idea is to protect investors from over-exposing themselves to higher-risk asset classes such as equities, which are prone to sudden corrections, by effectively forcing them to diversify into a mix of asset classes. While forcing investors to be prudent may appear to be a noble intention at first glance, a cynical free-market aficionado might argue that it smacks of nanny state interventionism.
After all, why punish informed investors who may have very good reasons for wanting to invest their monthly retirement contributions in an aggressive equity fund in order to protect ignorant investors who couldn’t tell the difference between a dividend and a bond yield?
For example, if you invest the retirement savings you’ve already accumulated throughout your career in a well-diversified range of asset classes (as per the Regulation 28 requirements), why not expose 100% of the monthly pension contributions deducted from your salary to equities?
Even if the market corrects you are still buying on the cheap so who cares when your accumulated retirement savings are already well-spread across the full spectrum of asset classes at your disposal?
A short conversation with Anne Cabot-Alletzhauser, Head of the Alexander Forbes Research Institute, is enough to convince one that Regulation 28 has its merits. The fact that Cabot-Alletzhauser hails from the US – the veritable Land of the Free where individualism and free market principles are worshipped on the altar of Wall Street – should also not go unnoticed.
Saved by Regulation 28
“In a developing country like South Africa which does not have the luxury of a comprehensive social security net, coupled with the fact that the savings rate is very low, the government simply cannot take the risk of letting people make the wrong investment decisions,” she says.
“Regulation 28 is not to be sneered at. There are a lot of people out there who have been saved by Regulation 28 even if they don’t actually realise it.”
Even more to the point, Cabot-Alletzhauser says that her 35 years of experience in the investment industry has taught her that an individual’s capacity to apply their intellect and knowledge to an investment decision probably exerts less than 2% influence on the performance of their investment in a particular share.
“I don’t care how smart you are, there is simply no way that you are going to outsmart and out influence Mr Market,” she says. “Human beings are also spectacularly bad at making the right behavioural decisions for their retirement futures. For that reason alone it helps to have some set of guidelines like Regulation 28 in place.”
Cabot-Alletzhauser says that some research has shown that between 40% and 70% of a particular share’s performance is determined by outside factors ranging from the general performance of the market, the performance of the sector that it operates in as well as that of its peers, rather than its own characteristics.
Once you begin diversifying your investment across a number of shares, as is the case with an investment in an equity-focused unit trust, the overall influence of 'Mr Market' on your overall investment climbs to over 90%, she argues.
This is precisely why so few portfolio managers are able to consistently beat the market – because the overall market is really the number one factor that determines the performance of the portfolio they’re managing.
“Diversification is what helps you reduce the specific risk of a share or sector while Regulation 28 aims to reduce the specific risk associated with a particular asset class,” she says.
“You may argue that government is forcing you to diversify but you also have to look at it from their point of view. They don’t know when a particular investor plans to cash out of a fund but they do know that if that investor is 100% exposed to equities and the market crashes just before they’re due to retire, they’re going to have their retirement plans blown up.”
Of course, another thing to remember about Regulation 28 is that it only applies to your pre-tax retirement contributions.
There is absolutely nothing stopping you from investing a portion of your after-tax income in an aggressive equity instrument like the Satrix 40 or the highly-rated Foord Equity Fund. What’s more, thanks to government’s newly launched tax-free savings account, you can do so in a tax efficient manner to boot.
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