South Africa: Green light for infrastructure investment by retirement funds?

Draft Amendments to Regulation 28 of the Pension Funds Act (draft amendments), which were published by National Treasury earlier this month, will allow retirement funds to invest up to 45% of their assets in infrastructure, opening up a huge potential source of funding for domestic infrastructure projects. But will this help bridge the infrastructure gap, as Treasury hopes?

South African retirement funds are subject to quantitative investment limits, which are aimed at promoting diversification and limiting the risk of bubbles emerging from too many assets chasing too few opportunities. Whilst these limits are generous for ‘mainstream’ asset classes (for example, funds may invest up to 75% of their assets in equities or in non-Governmental debt instruments), ‘alternative assets’ get short shrift – funds may invest no more than 15% in private equity, hedge funds and ‘other assets’ combined.

The draft amendments, which were open for public comment until 29 March, open up opportunities for retirement funds to invest in alternative investments by allowing them to invest up to 15% of their assets in private equity funds, 10% in hedge funds and 2.5% in ‘other assets’. Most eye-catchingly, funds can now invest up to 45% of their assets in domestic infrastructure, plus an additional 10% for the rest of Africa. Infrastructure is not categorized as an asset class, like equities, debt instruments, or private equity or hedge funds. Rather, the limit acts as an overlay, recognizing that infrastructure investment may take many forms. Arguably, this imposes a limit where none currently exists (theoretically there is nothing stopping a fund investing 100% in infrastructure, provided that the investment is structured to fall within the existing class limits).

It is clear, however, that the addition of this limit signals a clear policy intent on Treasury’s part – the media statement that accompanied the draft amendments states that these amendments “provide government’s response to calls for retirement fund investment in infrastructure to bridge the infrastructure gap”. As further evidence of joined up thinking, ‘infrastructure’ is defined in accordance with the Infrastructure Development Act, which is, in turn, defined by reference to the national infrastructure plan.

Industry’s response to the draft amendments has been broadly supportive – not only is there relief that the measure is permissive rather than prescriptive, but there is a recognition that infrastructure investment, with its long-term income streams, is well suited to funding pension fund liabilities, which are equally long-term in nature. There is plenty of international precedent for infrastructure investment: Australian, Canadian and Dutch pension funds have been doing it for some time and the trend is accelerating among UK pension schemes, driven by historically low interest rates.

The proposed amendment will not, however, bridge the infrastructure investment gap by itself. To date, there has been little enthusiasm among South African retirement funds for infrastructure investment – historically, mainstream assets have returned well, and infrastructure investment has seemed too ‘exotic’ and, in light of chronic mismanagement of some projects, too risky.

But timing is everything and the Government’s timing is good, as the environment for infrastructure investment by retirement funds has never been better. Following a decade of consolidation, many South African retirement funds now have the economies of scale and governance budgets to make infrastructure investment a realistic proposition. Infrastructure investments typically require substantial minimum investment, offer better terms for those who invest greater amounts, and can involve considerable cost in the due diligence of what can often be highly complex legal structures. More recently, COVID-19 has brought volatility to listed equities and decimated property investment, which, together with a low interest environment, can only increase the demand for so-called alternative investments.

Infrastructure investment can also tick the sustainable investment box. Retirement funds are required by law to consider any factor which may materially affect the sustainable long-term performance of an investment, including environmental, social or governance (ESG) factors, before investing in it. Globally, ESG factors are now viewed as an integral part of retirement funds’ investment strategy, recognizing the long-term drag on society (and, correspondingly, on funds’ investment return) of failing to take them into account. Investment decisions must still be primarily motivated by the interests of members. On the face of it, Treasury’s statement that the proposed changes are “informed by a number of calls for increased investment in infrastructure given the current low economic growth climate” rings alarm bells, as it seems to suggest that retirement funds are expected to come to the rescue of the economy at the expense of their members.  But that circle is easily squared: investment by retirement funds in infrastructure acts as a driver for economic growth which should, in turn, have a positive impact on the performance of the fund’s assets. Treasury sees this as a win-win scenario.

The final ingredient is to ensure that there are a sufficient number of suitable infrastructure projects for funds to invest in. The Government wants improved infrastructure to play a key role in South Africa’s Economic Reconstruction and Recovery Plan and, in 2020, gazetted plans for 51 fast-track infrastructure projects. However, for the Government to tap into the increased availability of funding from retirement funds, infrastructure projects will need to be technically sound, well planned, properly governed and offer funds stable returns over an extended period.  If the right opportunities present themselves, retirement funds will invest and the Government will be on its way to narrowing the infrastructure gap.