The much awaited, and patiently hoped for, provision for pension fund offshore investments has now been made into law. For most in the industry, it has been like watching paint dry ahead of an oncoming storm. Some would argue, on two clear instances the devastating storms arrived before our paints dried up, losing a lot in the misfortunes. The two instances are the two hyper-inflationary environments of 2008/2009 and the current one of 2020/2021. Maybe, and only maybe, some bit of exposure to offshore investments would have salvaged portions of workers’ retirement fund savings if only it had been provided for earlier.
Of course, that things could have been done differently is never in dispute, but that’s not the point of discussion here. True, the best time to provide for offshore investing was back then, and the second-best time is now – and here we now have it.
In fact, the more important question right now is two-fold, what’s next for pension funds, and how so? No doubt, pension funds have been desperately sitting on edge looking to the day when they could expand their investment universe to economies and markets outside of Zim. That desperation though now needs to be tamed and replaced with caution. Not only are offshore markets complex, they are also risky, costly, involving, and difficult terrains to navigate – one wrong-and-rushed decision and a fund will live with the regret for many years to come. The dilemma of course is real, for how long further can you stay-on locally invested with asset values fast eroding due to inflation, while you move cautiously into the offshore markets. Investment consultants now have a real job to earn their fees on this one as they help trustees engage with a totally new environment and experience.
Too Little too Late?
But maybe, first let’s highlight the massive benefits that this new regulatory provision brings about before we over-dwell on the challenges and problems that lie ahead with respect to its execution. While for many, the biggest question is going to be on how pension funds will secure the much-needed foreign currency, will the Reserve Bank, for instance, make provisions for this, will pension funds be allowed to participate at the auction system, what other options are there for pension funds to secure the foreign currency, and many more. These are all certainly very valid concerns. Some have been tempted to feel that with its maximum allowable limit capped at 15%, this is disappointingly way too little and too late. Of course, even at a 100% provision, if the foreign currency cannot be secured then there is absolutely no offshore investing worthy of having a conversation around. Compare this to just three or so years ago, during the era of the multi-currency regime, there would not have been any real foreign currency challenges to talk about. Can you imagine the many livelihoods and family fortunes that could have been saved if only this provision had been made then? Maybe, it is indeed too late.
That certain aspects of the Exchange Control provisions will require amendments is not in question, otherwise the entire policy framework will be lacking in harmony. But let’s come back to that later, first the benefits of this new pronouncement from the regulator.
This list is not exhaustive, it though highlights some of the salient benefits of what this new regulatory regime brings about for retirement fund members.
Offshore exposure offers a multitude of obvious benefits, top on the list are a much bigger investment universe and protection against currency weakness. The ZSE has just over 50 counters, compared with the tens of thousands available globally. Beyond the numbers, there are sectors and markets that are simply not available on our local market. Social networking, e-commerce, electronic car manufacturers, alternative energy, or biotechnology are just some examples of many fast-growing industries heavily under-represented on our local bourse. In fact, the entire “new economy” supply chain is non-existent at all on our stock exchange.
Diversification remains the only “free lunch” available in investing. A local-market-only-constrained strategy is not a balanced strategy. It’s an incomplete strategy that fails dismally on the diversification dimension. Offshore exposure is not just a “nice to have” allowance, it is a fundamental requirement. It allows for diversification in the true sense of the word. Even if the current pension fund portfolios have some resemblance of diversification, they are all only ZW$-based. Needless to say, this carries with it a significant amount of risk. Investments offshore in hard currencies bring diversification to the portfolios in a meaningful way.
Exposure to Broader Opportunities
True offshore investment products are based and managed offshore, by globally recognised asset managers with the right track records, registered, regulated, and licensed to operate in global markets. Thus, not only does offshore investing bring about diversification across markets, economies, jurisdictions, geographies, currencies, sectors, companies, and opportunities, it also ushers in diversification across investment managers and investment management styles.
Our contribution to global GDP is less than 0.1%, so offshore investing gives us exposure to more than 99.9% other opportunities out there. For instance, while we have been endless spenders on products of tech giants like Facebook, Amazon, Google, Apple, Netflix, Microsoft, and others, now we can be shareholders in them too.
Our stock market is not only relatively tiny, it is also heavily concentrated in a few counters. The top 10 counters alone make up about three quarters of the total market value of the bourse.
Critical to emphasize here that trustees need to be clear on what fundamentally is at the core of going offshore. Failure to have clarity on this could be a source of huge disappointment in the future. While performance enhancement could be one of them, it is not the primary reason of going offshore. Instead, at the core of going offshore is protection of assets as opposed to simply a desire to make money, for money could actually be lost offshore.
Thus, as highlighted above, the main purpose of investing offshore should be to diversify a fund’s investment portfolio by gaining exposure to broader world markets and currencies which are more mature and stable, respectively, than our own market.
Offshore investing is however pregnant with its fair share of challenges.
Accessing Global Managers
If picking an asset manager from our own universe of asset managers here is difficult for trustees, knowing where to start from, let alone picking an asset manager globally is such a mammoth task. Not only does it require skill and expertise, it also requires a depth of manager research resources and a deep knowledge of the global markets that only very few can command. It is certainly challenging for the expert, it is near-impossible for the amateur.
An alternative would be if local asset managers, known to pension funds already, could establish feeder portfolios that direct assets into known global asset managers’ portfolios. That way, pension funds would rely on the competence and integrity of local asset managers to enter partnerships with the right global asset managers. That, of course, does not exonerate boards of pension funds from carrying out their own due diligence exercises on those global partners of local managers. There are two problems with this approach though. First, there would be a serious limitation in terms of the number of global asset managers that pension funds would have access to, as in the majority of instances, any one local asset manager will at most only be able to partner with one global asset manager and nothing more. Secondly, there is no guarantee that every asset manager approached would be willing to bring their investment products into Zimbabwe.
A much easier route would be if the local asset managers were ambitious enough and went on to set up their own global portfolios. Of course, with no track record of their own, no prior experience, limited technological resources, it is highly unlikely that any of these asset managers would pass a robust due diligence process for an offshore mandate.
A Complex Environment
While locally, trustees have been getting away with directly picking a stock, or two, or a handful of them on their own, or with some little advice, this would be considered a taboo on the global markets. In fact, even locally, picking stocks directly should never be done by anyone other than full time investment professionals whose day job is looking at, and analysing, capital markets. Where this has been happening, the regulator should come out in full force condemning it in the strongest of terms. Not only is it against standard practices, it is a highly risky and speculative act, tantamount to institutional gambling with members’ monies.
With all the seemingly easier routes off the table, pension funds will have to brace themselves for the least smooth, albeit potentially most rewarding, route – going out into the global markets in search of the asset managers with the right fit. Of course, the choice of jurisdiction must be considered, cognisant of the need for a developed system of contract law and comprehensive trust law. Other considerations include, political and economic stability, taxes on income or capital, activeness of banking sector, effectiveness of communications, logistics and time differences, professional, corporate and banking services, and a whole host of other requirements.
The political turmoil on Capitol Hill in the US at the beginning of 2021 ushered in a new perspective on how naive one could be on completely eliminating some jurisdictions as potential bastions of political risks. It bore evidence that social, political, and economic challenges are endemic, and money invested in any country is exposed to that jurisdiction’s particular set of challenges and risks. Trustees must be seen to be acting in utmost good faith and demonstrating the degree of care that a prudent person would exercise, in the choice of the investment destinations they make.
It is worthy of emphasizing that, while the jurisdiction of domicility is an important consideration when going offshore, it is by no means the only consideration of interest. Part of the real risk involved in any offshore investment also depends largely on the companies in which the asset manager invests in and the countries they operate in. A US-domiciled asset manager investing in Afghan stocks is probably not as safe as it might appear on the surface. While this is probably an extreme case, as no US-registered and licensed asset manager is likely to be allowed to invest in Afghanistan, the point is, trustees need to do their homework.
Uninterested Global Managers
Trustees should carefully consider the currency in which the investment is denominated, taking into account the fluctuations of the currency in relation to other currencies, and our own currency. Critical to mention that it is not only necessarily the currency of the jurisdiction in which the investment is legally domiciled that matters, but the currency in which the investment itself is denominated.
An interesting dynamic is though likely to play out along the way – one where global asset managers refuse to take our assets on the grounds of the prevailing US sanctions, or their negative perceptions of our regulatory framework, or just not wanting to take the perceived legal risk of having a Zimbabwean entity as a counterparty to a contract that they fear would not be easily enforceable. That, to us, is by far a much bigger and real hurdle that will need to be crossed than picking and choosing which countries we can take our assets into. Certainly, yet another instance where investment consultants will need to earn their fees as they help trustees navigate such obstacles. It is very difficult to imagine how, even they, could help without introducing creative implemented investment consulting offerings, or full-blown multi-management solutions altogether. Of course, the challenges of selecting global asset managers do not disappear simply because the responsibility has been passed on to an investment consultant. They too require having processes and systems in place to properly research and allocate to asset managers at a global scale.
Politics, legal systems, and sanctions aside, some asset managers will simply not take investment mandates where the mandate size is very small. Where appointments involving several hundreds of millions of US-dollars dominate the conversations, a couple of dozens of millions of dollars only from a Zim pension fund might be considered a waste of time. This immediately closes the doors for most of our pension funds, even some of those that we count amongst our very big ones. This is especially more so considering that in the whole, it is only a maximum of 15% of their assets that they will be attempting to take offshore.
Where we are lucky and some global asset managers decide to come down and market their products and solutions directly into Zim, not only would their country of origin need to pass our tests, the portfolios they will be selling here will also need to pass some onerous scrutiny here from SECZim. This, would apply, even if they do not intend to register as an asset manager here. Of course, while the best prize would be if the global asset managers could come and set up shop here, the reality is, it is way too premature to dream of a day when such a development could happen.
Taxes, Costs, and Currency Fluctuations
With the hope of global asset managers taking the lead and coming down here first far into the distant future, the costs of accessing these managers using our own channels are going to be quite high – a factor pension funds need to take into account when discussing their offshore opportunities. The return benefits of any such opportunities could easily be eaten away by the costs of accessing them. Again though, we are reminded that return enhancement per se is not the sole reason for going offshore.
Another factor to consider is the tax regime of the jurisdiction in which the offshore investment is domiciled. While our pension funds’ local investments are largely tax exempt on both income and capital gains, there is no guarantee that they will be treated the same when they go offshore. An otherwise good yielding investment can easily become a bad investment if excessive taxes are applied on the returns. The good thing though is that there are countries that have strategically set their markets as the premier global investment centres and portfolio administration hubs with very accommodative laws on investment income and capital gains tax. Most offshore funds are generally established in such countries that provide tax-efficiencies and reliefs to investors abroad.
To reap the maximum benefits of offshore investments, a long enough investment horizon should be allowed for. Assets of retirement funds’ members very close to retiring might not be an ideal target for offshore investing. This, of course, would be a call that trustees would need to make as part of a broader asset allocation decision.
In the rush for the exit door to take money offshore, trustees need to be reminded not to consider it a given that our currency will forever be depreciating. At the rates at which it is right now against any major hard currencies, prudence would invite the question, “what if it were to start appreciating?”. For every point of appreciation, our currency would eat into whatever returns the offshore investments would have earned in foreign currency. Trustees should be concerned about this especially if the efforts of our policy makers and the Reserve Bank start to pay off. Of course, we can already hear our critiques asking us to be real with this one.
The strategy should never be to attempt timing the market for the offshore exposure. If there is one market that is extremely vexing to time, it is the foreign currency market. No long-term investor is advised to even think of attempting it. A textbook solution to mitigate the risks of the exchange rate adversely moving against the pension funds would be to consider drip-feeding the assets into the offshore portfolios, that is, staggering the investments into offshore portfolios based on hard currencies secured at different rates over a prolonged period of time as opposed to going all in at once.
Just the Tip of an Iceberg?
The one main question not specifically addressed here is that of how pension funds will secure the foreign currency required to invest offshore. We will cover that in our next articles that are specifically addressed to attend to that. What we can say, of course, is that those pension funds with any residual foreign currency reserves sitting in their nostro accounts, or those whose employers are generating some revenue in foreign currency, and can thus pay contributions in foreign currency, will have an immediate source for the required foreign currency for offshore investments.
The second question that was not for discussion in this article is on the adequacy of the offshore investment allocation itself – at a maximum allowable limit of 15% of total assets. While this will be discussed in the future, for those who want to know right away, our view is that 15% is very much a respectable and decent point at which to start from.
Offshore investing is such a massive, interesting, and rewarding pursuit whose details and dynamics cannot though be covered adequately in just one article. We hope to be back again with more.
What is clear from the above is that while the provision is now in place for offshore investments, there is a lot that trustees still need to ponder on. Offshore investing is complex and requires a comprehensive and well thought-through asset allocation strategy and a policy framework that ensures good governance oversight, control, and compliance.
On the part of the industry, real work begins now. Members are expectantly waiting on the expert practitioners to navigate the novel universe of opportunities now available to them as they come up with cost-effective investment opportunities with the potential to generate superior returns within acceptable levels of risk.
Our monthly publication is aimed at inviting conversations from like-minded individuals with a view to engaging in forward-thinking-led discussions on how we can collectively improve the state of our industry.