Be careful to invest more offshore just because you can

By Andró Griessel

30/9/2023

Early in 2022, the permissible percentage for pension funds and retirement annuities to invest offshore was increased from 30% to 45%. This change to Regulation 28 of the Pension Funds Act was welcomed by most people in the retirement industry, but will it necessarily lead to better outcomes for investors?

I’ll attempt to answer that question shortly, but what I do know is that it will lead to greater variation in outcomes between the performance of your typical balanced fund, the category to which most investors have exposure.

The reason why the increase in foreign allocation has been widely welcomed probably has to do with the fact that the restriction on foreign exposure has made it nearly impossible for managers to beat inflation by more than four percentage points (especially after performance and administrative fees) over the past decade.

Apart from resources and international equities (specifically from the United States), most other asset classes have fared poorly, and balanced funds have taken the brunt.

Does a greater choice of asset allocation, however, lead to better outcomes for clients?

Intuitively, it should, as you have the freedom to invest wherever and in whatever you prefer. A skilled fund manager should be able to adjust their sails to ensure you get the best possible outcomes.

But when I look at the numbers, it seems like it’s easier said than done.

The fund category that certainly provides the most freedom to fund managers to construct portfolios without limitations is the worldwide flexible multi-asset category, according to the classification of the Association for Savings and Investments. Funds in this category have no restrictions on geographical exposure or asset allocation and can theoretically vary from 100% in South African cash to 100% in foreign stocks, and anything in between. For context, over the past ten years, the JSE Capped Swix delivered a meagre 6.89% annual growth while the MSCI World Index achieved 16.01%.

In light of these figures, one would thus expect that a fund manager with complete discretion should have achieved significantly closer to 16% than 7%.

However, the average return of the 27 funds in this category with a ten-year or longer performance history was only 8.9% per year!

Contrast this with the average performance of managers obliged by Regulation 28 to invest more in South Africa.

It makes for interesting reading.

In the South African flexible multi-asset category, the average fund manager delivered 7.2% per year, and in the South African multi-asset high equity category, 7.42%, both better than a 100% allocation to a weighted average of South African equities would achieve.

Though still strong in nominal terms, I would venture to say that managers who had limitations on their ability to allocate overseas performed significantly better from a relative perspective than those who had free reins.

If I had to guess, I would blame a “home bias” for the relative underperformance of the global multi-asset flexible category.

In other words, even though these managers could allocate 100% to foreign assets, they probably still had a large portion invested in South Africa.

This assumption is possibly supported by the fact that the average fund in the global multi-asset flexible category (where a minimum of 80% must be invested overseas at all times) outperformed its “worldwide” counterpart by approximately one percentage point per year.

What have fund managers done with their newfound freedom since early 2022?

Some managers now have double the foreign exposure they had, while others, for whatever reason, have almost removed their total exposure.

Overall, managers have significantly increased their foreign exposure. As an example, look at how the Allan Gray balanced fund (the largest balanced fund in South Africa) has changed its allocation over this period..