Menu

An Analysis

While the assets in African pension funds are still relatively small, most are fast growing, creating local pools of capital for investment.  In many countries, assets are growing much faster than products are being brought to market, limiting investment opportunities if regulation does not allow for pension funds to invest outside of their own countries.

Assets in East Africa, for example, have grown in excess of 20% on a consistent basis, only overshadowed by Nigeria, which has seen growth between 25% and 30%.

Currently Namibia allows up to 35% of assets outside the Common Monetary Area (Lesotho, South Africa, Namibia and Swaziland), with a limit of 30% outside Africa, while Botswana allows up to 70% investment abroad. In South Africa, pension funds may invest as much as 30% of their assets outside the country’s borders.  This is in contrast with East African countries such as Uganda and Tanzania where offshore investment is generally not allowed outside the East Africa Community region.

The type of assets in which pension funds may invest is also an issue.  There are often significant differences between the regulatory allowances for pension funds, size of local capital markets and actual portfolio allocations. This is reflective of a number of factors, including familiarity with alternative asset classes, such as private equity, development of local capital markets and availability of investment opportunities.

In developed markets, far fewer –- if any -- restrictions are placed on pension schemes about how they invest.  As a result, they invest in a broad range of alternative assets.  Moreover they invest internationally, and this is a trend that has steadily increased over the years.  

Diversification is spreading your investment bets rather than artificially constraining to a particular form of an asset class such as listed equity or government debt.  

Diversification brings the benefit of correlation. If two assets classes have low, and ideally negative, correlation then the correctly determined blend can have lower portfolio risk than either asset class in isolation.  While individual returns combine linearly, the risk does not; and the aim is to prevent unnecessary risk at the portfolio level as risk acts a drag on returns.  In a controlled manner, an African pension fund wants access to a broad diversified investment universe.  This includes alternatives to complement traditional listed fixed income and equity.  

And a broad investment universe means non-domestic. Investing offshore does bring currency risk, and this has greater impact for fixed income rather than equity; in fact the currency risk can often mitigate some of the inherent risk of an equity asset class.  While asset-liability studies (for defined benefit pension plans) or portfolio construction exercises (for defined benefit pension plans) often give allocation to alternative asset classes in the 5-10% range, the optimal allocation to non-domestic investment can often be far higher.

With pension fund assets growing at a brisk pace, identifying appropriate local investment and development opportunities can be challenging.  This shows the need for pension fund regulators to allow more alternative and more regional/international investment by pension funds to better their diversification. If the risk-return trade-off exists, then diversification is always good.  

Appropriate safeguards will be needed of course to prevent misguided investment in what may be new and unfamiliar asset classes. In markets where there are no limits on allocation, expert investment advisers are there to guide and educate the trustees to ensure fiduciary responsibility is maintained and investment is done in a proper fashion.  The bottom line is that the greater the diversification the less the drag on returns and that enhances the security of pensions in Africa.

Andrew Slater has MA Mathematics. He is Fellow of the Institute of Actuaries, and CFA Charter-holder. Andrew’s 20-year career in investment has taken him around the world, with pension funds and wealth management institutions ranging from high-net-wealth private banks to mass-market DC providers. He originally qualified with PriceWaterhouse as an actuary, later turning to asset management with S.E.I. Investments. Andrew is an alumnus of Cambridge University (undergraduate mathematics and postgraduate theoretical physics) and London Business School.

The author acknowledges the helpful conversations with Fiona Stewart at the World Bank regarding this article.

*RisCura is a global, independent financial analytics provider and investment consultant. RisCura services institutional investors with over $200billion in assets under management, as well as a significant number of asset management, hedge fund and private equity firms.