The worldwide investment landscape offers South African investors a much wider range of possibilities for a diversified, robust retirement savings portfolio. For clients seeking greater choice and more security, exchange traded funds (ETFs) and linked investment service provider (LISP) platforms should be strong contenders for consideration, offering an efficient, cost-effective entry into a global investment universe.
Retiring in two steps
It is well known that few South Africans can afford to retire comfortably. The goal is to accrue a capital base large enough to draw sufficient income from post-retirement. So, as step one, it is imperative to assess a client’s reasonable income replacement ratio. The more time a person has to save, the less they need to save to achieve a given income replacement ratio.
Given only a small portion of South Africans are able to retire comfortably, it is safe to assume that most South Africans are either starting too late or not saving enough. Intermediaries can play a pivotal role in helping clients set the right target and structure their financial affairs to save adequately. Offshore investments should be part of the planning process.
The more time a person has to save, the less they need to save to achieve a given income replacement ratio.
Step two is determining how the investments within a retirement savings vehicle or wrapper will be managed in order to deliver inflation-beating returns.
These investments need to comply with Regulation 28 of the Pension Funds Act. There are typically two broad approaches:
- Investing in one or more Regulation 28 compliant multi-asset funds, where the investment manager of each balanced fund will decide on the investment approach and asset allocation to ensure compliance with Regulation 28;
- Constructing a Regulation 28 compliant portfolio using specialist funds (typically providing exposure to a particular asset class), thereby allowing greater control of the investment approach and asset allocation. Note: this approach would require more frequent monitoring of compliance to Regulation 28.
Offshore investments can constitute up to 30% of a Regulation 28 compliant portfolio, with an additional allowance of 10%, which can be invested in the rest of Africa. This 30% provides an obvious opportunity to diversify away from the risk of our local market and access investment opportunities that are not available in South Africa. However, while opportunity offshore abounds, there’s also potentially more chance of getting those investments “wrong”. ETFs provide a prudent way to mitigate this risk. They typically provide broad market exposure to a particular asset class (equities, bonds, etc).
Research has overwhelmingly shown that, after costs, investors typically outperform the average investor by some margin due to the cost advantage of these products. This is a classic opportunity cost problem; either take the additional risk of trying to outperform a benchmark – which will cost more and could result in significant underperformance – or put the odds in your favour of outperforming most funds on a net of fees basis by tracking an index.
Some active fund managers are able to outperform their benchmarks and indexes. However, overwhelming research shows that fewer managers are doing so, and the frequency of the outperformance over various time periods or through different investment cycles is also on the decline.
The inclusion of ETFs on LISPs
Recent innovations in the LISP market have allowed the inclusion of ETFs on the platforms where most investors’ retirement savings are administered. This is ideal for investors wishing to adopt other investment strategies or themes over and above asset allocation.
Recent innovations in the LISP market have allowed the inclusion of ETFs on the platforms where most investors’ retirement savings are administered.
It is now possible for an investor (or their financial advisor) to include ETFs along with unit trusts seamlessly within a single portfolio on a LISP platform, thereby providing increased choice and granularity within the offshore investment opportunity set. ETFs are a more efficient vehicle to bring new investment strategies to market and solve the Achilles’ heel of unit trusts – small fund size.
As a result, ETF issuers like Satrix have been able to roll out a wide variety of global investment strategies, which would not have been possible with unit trusts alone. Beyond providing broad asset class exposure in the form of ETFs tracking MSCI World, MSCI Emerging Markets or Bloomberg Global Aggregate, an increasing range of investment options operate in the thematic space.
These are longer-term megatrends, which are likely to shape markets for the foreseeable future. They include:
- Shifting economic power – the rise of new economic centres of power, especially in eastern markets.
- Technological breakthrough – the increasing influence of technology in our daily lives from an information/communication (eg Alphabet and Meta) and services (eg Airbnb and Uber) perspective and from a medical technological breakthrough perspective. The companies pioneering and commercialising these breakthroughs have the potential to be uncorrelated from the prevailing economic cycle, adding the potential for further diversification.
- Climate change and resource scarcity – we will see increased awareness and the adoption of sustainability-focused investment strategies, which consider environmental, social and governance (ESG) criteria or aim to make a positive impact in the process of delivering a return.
The additional benefit of offshore investing
An additional benefit of offshore investments, apart from the higher growth developed markets have delivered over the last 10 years, is that in rand terms, they have offered an extra layer of diversification and protection when global markets have sold off. These periods are typically accompanied by a weakening of the rand, which has had the effect of cushioning any losses in offshore assets.
The range of offerings within South Africa has been somewhat limited (90 ASISA Global Equity General vs 177 ASISA SA Equity General unit trusts). For investors seeking greater choice in constructing the offshore component of their retirement savings portfolio, the introduction of ETFs to LISP platforms increases the investment choice efficiently and cost-effectively.