Q&A: The challenges facing pension funds from SA’s new higher offshore and infrastructure investment limits

At a recent breakfast for institutional investors, guest speaker Sonja Saunderson, Chief Investment Officer of the Eskom Pension and Provident Fund (EPFF), discussed the real considerations, concerns and decisions facing South African pension funds in today’s expanded investment universe. She spoke to Naleni Govender, Executive Head: Institutional Distribution at M&G Investments.

Naleni: As an asset manager, we’ve seen many clients taking exposure offshore under the new Regulation 28 limits, but wanted to hear directly from the institutional market. Sonja, how have you experienced this change and what are the challenges that retirement funds face?

Sonja: When the amendment to Regulation 28 came out, I was still working at an asset manager, and I remember being pleasantly surprised when the offshore limit increased to 45%. But when I moved to a pension fund, I realised that this industry isn’t quite ready to take up this opportunity, nor was the institutional industry as a whole. There are so many questions around where to invest. How much exposure should we have? What is the impact for members if we take the full 45% allocation? Are we being disloyal to South Africa if we put money offshore? Should we invest in the real economy in SA? These are the questions that institutional investors are grappling with.

Also, pension funds know the local fund management and consulting fraternities. There is a level of trust; but once you go offshore, it’s different. And do we become insignificant to global asset managers as our rate of exchange makes us so much smaller? Will you get the same level of service if you go offshore?

Our members are based in SA, and our liability is in SA as the bulk of members will retire here. Yes, you need to consider diversification, but also our societal and corporate responsibility to South Africa.

Naleni: Do you think there is enough local manager research available to assist pension funds with finding innovative solutions that add value and alpha to their members?

Sonja: Not all pension funds have dedicated resources that can do research on their behalf. Yes, there is expertise in the market, but it lengthens the value chain as you’re connecting with people offshore and getting to know them. I see many unknown names overseas. You need resources to scour the world. We like to partner with overseas investment firms that have the research resources and the databases of investible opportunities. But first the strategy needs to be clearly defined to find the best service provider to execute on that.

There is also the issue that many pension funds are managed on a balanced or multiple balanced fund basis. Suddenly you can invest up to 45% of your fund offshore; or your balanced manager will increase their offshore exposure to 45%. But you need to understand the role that the manager’s exposure will play in your portfolio and the risk that opens up. While I’m not advocating for a specialist versus balanced approach, a pure balanced strategy may not be appropriate anymore. The new limit requires pension funds to determine what they are trying to achieve for their members and to get the right expertise to achieve that and, by and large, local pension funds don’t have that skill right now.

Naleni: Yes, it’s important to partner with an asset manager with both local and global expertise. In addition to the 45% offshore allocation, pension funds are now also allowed to invest 45% in infrastructure; and there is certainly a need for infrastructure development in this country. How do you view and manage this?

Sonja: While there aren’t a lot of listed infrastructure options yet, we are fortunate to have some exposure, and we are working with local asset managers to mobilise more listed opportunities. There is also the fact that in South Africa, the listed universe overall is shrinking, yet funds still need to have 55% of their exposure to local assets. And while our members are excited about infrastructure assets, the first prize is still financial returns, so that pensioners can grow their purchasing power. However, we can still help with developing a healthier economy. While Europe is very strong on climate change, it’s not our first priority in South Africa.  We don’t feel the effect of climate change as much as we feel societal issues.

There are impactful things that can be done for society through infrastructure. Because we reside in an emerging economy, it’s positive that we can have more infrastructure exposure but we need to be cautious.

Naleni: I’d like to look at impact investing in the context of offshore. How do you implement an SDG (sustainable development goal) or environmental, social and governance (ESG) framework?

Sonja: There are many ways to do it. As a framework, the goal of the SDGs is to articulate consistent outcomes. We have spent a lot of time being clear about what is important for us and our members. Those outcomes aren’t split into local and global goals; that occurs in the execution. Our members want outcomes that talk to more equitable societies, financial wellbeing, a global environment that is progressive and fair; where health and wealth are shared more equitably. As a fund, you need to decide which SDGs are important to you, resonate with members, and can meaningfully be reached. We focused on social matters such as gender and race, and then we talked about economic parity in SA; how things were set up in the past, and financial access. Then we thought about environmental issues. Decarbonisation and the ozone layer issues are real and affecting the competitiveness of industry and financial growth, and whether our futures will be set in a certain way. In the global space, those same things matter. However, I think developed markets are in a better position to execute on certain themes like climate change.

In South Africa we need to think about a just transition. Are we going to put people working at coal mines out of jobs? No, we want to go through a just process that also addresses historic inequalities. We have much bigger issues here when it comes to diversity, equity and inclusion than global funds do. We still have people who don’t have access to basic services, including education and health.

Naleni: I agree. It’s about taking a strategic approach based on your members. Going back to listed infrastructure, what do you believe is the investment opportunity set for asset owners, consultants and multi managers when considering their offshore allocation into infrastructure?

Sonja: With an offshore allocation of 45%, there is definitely a case for being less equity-centric. It’s important to understand asset classes holistically and to be impactful – you can get good returns and make an impact at the same time. While I wouldn’t want to go into private, unlisted infrastructure globally, it makes sense in SA as we are located here. We are always looking for long-term liability matching, but when it comes to infrastructure, being listed helps a lot. Having access to prices on a real-time basis, for example, is very appealing. Also, pension funds require liquidity, which listed assets provide. It is very appealing to have the opportunity to invest in real assets without sacrificing impact, although it is a global, rather than local, opportunity.

Naleni: You joined EPPF as Chief Investment Officer in 2022. Well done for the excellent job you have done for your members. What would you have done differently had you been there (at EPPF) three years prior?

Sonja: Lots of things: hindsight is a terrible science. Overall, the fund is well diversified, but there has been geographical concentration to some extent because the old Regulation 28 didn’t allow a more diversified footprint. We bought into some ideas, for instance global developed market exposure, but felt China was always under-represented in the indices and we felt we were missing a growth opportunity that would help our fund. Aside from SA and some offshore, I would have liked to have the ability to look at growth areas like frontier markets, and Asian markets beyond China. That is something I would have liked to change. Most of our assets globally are listed, but we are looking at unlisted assets as well and have dabbled a little in this area in developed markets (North America and Europe). Looking at returns globally, there are great opportunities for growth that have arisen out of trends such as urbanisation, medical advances, and digitisation on the tech side. We may have missed out on some, but fortunately Regulation 28 is helping us to think about these.

Naleni: If you were the sole strategist on a retirement fund right now and SDG and ESG were your primary objectives, what would be the asset allocation between SA and offshore and then, regarding offshore in the face of Regulation 28, what would you do?

Sonja: My answer is somewhat of a cheat, as my fund is a defined benefit fund and my liability is in South Africa. For that reason, I’d have close to 60% in SA as we want to have an asset strategy that is closely matched to our liability strategy. Hindsight tells me I should have had a lot more developed offshore exposure and, on the emerging markets side, I wouldn’t just stick to South Africa. We don’t see local and offshore as two pockets. There are so many subclasses of returns, geographies, etc. Instead, we think about each asset class. How do we want to split local and offshore in equites, in bonds, and so on.

Because a real change is needed in SA and because Regulation 28 is still forcing us to have a local bias; and because most of the members are in SA, they care about what is going to happen to the country. So, I would say, even if our fund was unconstrained, I’d put the majority in South Africa while also looking for much more diversification from a global perspective.

Naleni: Thank you for sharing your experience and knowledge on global investing for Impact, Sonja – it’s been a pleasure getting your valuable insights.