Offshore investment: key considerations for retirement funds

Overview

In terms of Regulation 28 of the Pension Funds Act, retirement funds are now allowed to invest up to 45% of their underlying capital in offshore assets. This article considers the implications and opportunities of this new increased offshore limit.

Offshore investment under

Regulation 28 of the Pension Funds Act On 23 February 2022, retirement funds – together with prudential funds – got a reprieve from National Treasury to increase the maximum allocation of funds to offshore assets. In terms of Regulation 28 of the Pension Funds Act, retirement funds are now allowed to invest up to 45% of their underlying capital in offshore assets. Previously, they were allowed to invest a maximum of 30% of their capital in offshore markets with an additional 10% allocated to assets in the rest of Africa. Following the February amendments to Regulation 28, there is currently no difference between investing in the rest of Africa and offshore. In practice, retirement fund investment committees can now allocate significantly more to offshore assets.

Why is this important?

A greater allocation to offshore assets allows a retirement fund the critical opportunity to diversify risk. With more than 40 000 listed companies in the rest of the world, South African retirement funds now have increased access to share sectors that aren’t available locally. This opens up the investment universe to shares such as, for example, Swedish Saab, Danish wind-energy manufacturer Vestas and the world’s only uranium exchange-traded fund (ETF) in Canada, among others.

Another important consideration is the rand-hedge effect that a greater offshore allocation allows for retirement funds.

As the rand weakens, due to the inflation differential with major trading partners (SA historically has a higher inflation rate than developed markets for instance), almost half (45%) of a retirement portfolio is “hedged” and will increase in value.

How are offshore funds structured?

As the government increased the limits of offshore allocations over the years and relaxed foreign exchange controls – allowing South Africans to shift more money offshore – several unit trust funds investing abroad have been developed. According to the Association for Savings and Investment SA (ASISA), a voluntary industry organisation consisting of fund managers and life insurers, there were 609 foreign collective investment schemes (unit trusts) in SA at the end of March 2022. There were an additional 433 domestic funds that had mandates to invest offshore.

Foreign collective investment schemes are denominated in foreign currencies, such as the pound, dollar, euro or Australian dollar. They need to be registered with the Financial Sector Conduct Authority (FSCA) before they can market their funds in SA. In order to invest in these foreign unit trusts, retail (individual) investors will need clearance from the Reserve Bank. The Reserve Bank allows an individual to invest a maximum of R10 million per calendar year (R11 million if you include the R1 million single discretionary allowance) outside the Common Monetary Area (which includes South Africa, Namibia, Lesotho and eSwatini). Before the money can be moved offshore, the individual will need to prove that his/her tax affairs are in order with SARS.

To circumvent the onerous foreign exchange controls and processes, local investors can invest an unlimited amount of money in local offshore unit trusts. These unit trusts are denominated in rand and invest their underlying capital in foreign markets. All of these unit trusts need to register in terms of the Collective Investment Schemes Act (CISCA) and are regulated by the FSCA. Most of South Africa’s fund houses, who manage unit trusts, have one or more foreign funds with wide and flexible mandates to invest in foreign assets.

It is necessary to mention that foreign unit trusts and local unit trusts that invest offshore enjoy the same safeguards as those unit trusts that invest domestically. A unit trust is overseen by a board of trustees, whereas the investment decisions are made by an investment management company. The underlying assets never vest in the investment management company and remain the property of unitholders of the unit trust. The unit trust’s financial statements should be audited annually.

What types of offshore assets are available?

The broad classification of assets is the same for offshore and domestic assets. These include shares, property stocks, bonds, money-market instruments, hedge funds and derivatives.

Options to invest offshore

Various investment options exist for retirement funds opting to invest offshore. Broadly, these can be placed in three categories.

• Direct investing entails a retirement fund buying specific assets, such as stocks or bonds, directly on a foreign exchange. The fund will need to open a trading account with a reputable broker, usually large commercial banks in the foreign country, and ensure that it complies with the Reserve Bank’s foreign exchange regulations. This is a risky approach, as a retirement fund’s investment committee may be inexperienced and not necessarily have access to company research.

• Passive investing entails a retirement fund buying exchange-traded funds or exchange-traded notes on a foreign exchange. There is a multitude of these products that are linked to an index – which tracks a certain theme – compiled by a reputable indexation company. In this instance, the retirement fund will also need to open a trading account in the country hosting the exchange where the exchangetraded products are listed. It will also need to comply with the Reserve Bank’s foreign exchange regulations.

• Active investing refers to a retirement fund investing in unit trusts or hedge funds with a mandate to invest in foreign assets. Fund managers have dedicated analysts scanning the world’s stock markets for opportunities to invest in different companies, bonds or commodities. These unit trusts or hedge funds are actively managed by investment professionals. Where a retirement fund will need to adhere to foreign-exchange regulations when investing in foreign unit trusts, locally-managed offshore unit trusts don’t attract the same regulatory compliance, except for the 45% maximum allocation limit.

What are the benefits of investing offshore?

There are various benefits to investing a portion of your retirement funds offshore:

Diversification: Exposure to a single currency or country increases a portfolio’s aggregate risk. Diversifying the portfolio’s exposure may enhance returns and reduce the risk associated with a single market.

Capital stability: Diversifying investments across markets and different currencies reduces the impact of currency depreciation or political events specific to a single market.

Choice: South Africa is a concentrated market with only about 330 listed shares and a comparatively small corporate bond market. Most locally listed bonds are issued by financial institutions and attract relatively low yields due to their high quality. Expanding an investment landscape makes it possible for a fund to invest in industries, debt classes, commodities and specialised property stocks which are not necessarily available locally.

International obligations: In a rapidly shrinking world with many retirees opting to spend their last years in foreign countries, a sizeable offshore allocation makes sense. It will act as a hedge against rand depreciation, ensuring that a large portion of retirees’ retirement capital remains denominated in a foreign currency.

REFERENCES

• ASISA. Available online: https://tinyurl.com/mr3r2fbn

• South African Reserve Bank. Available online: https://tinyurl.com/mueuv8vz

• National Treasury. Available online: https://tinyurl.com/255r3f4b

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