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Can impact investing help transform retirement fund returns and our economy?

By Mervyn Shanmugam, CE: Alternatives at Sanlam Investments

The Covid-19 pandemic is having a profound and lasting impact on the South African economy. Add to that the reality that we entered Covid-19 already in a recession and, on top of that, have been experiencing a persistent low-return environment for the past five years. There is unquestionably a need to revive economic growth in South Africa, AND invigorate returns for retirement fund members to make sure we can leave a legacy for tomorrow.

In this context, surely it makes sense to add alternative-type investments to portfolios as a powerful diversification tool, an alternative source of alpha and a way of contributing positively to our struggling South African economy?

Why alternative, specifically, impact investing?
Alternative investments can be broadly defined as non-traditional ways of investing and include debt funding vehicles (such as private debt and corporate debt in the form of loans), private equity (buy-outs and venture capital) and more. Responsible investing falls into this category too. And these all hold the potential for providing higher than average returns. The reality is that they have a place in nearly every portfolio: they could be a potentially powerful lever for retirement funds to diversify, spread their risk and enhance returns.

Effect of including alternatives into retirement fund portfolios
More importantly, we can take advantage of the full mandate of Regulation 28, which allows up to 15% of assets under management to be allocated to unlisted “alternative” vehicles. There is certainly far more capacity available for fiduciaries to adjust their portfolios to take greater advantage of the attractive potential returns on offer.

Traditional asset classes are no longer yielding satisfactory returns
For the longest time, pension funds had done extremely well just by investing in traditional asset classes, so there was no compelling reason to look further afield at alternative asset classes. In the last five years, however, these asset classes are no longer yielding attractive real (above inflation) returns, and may be preventing us from meeting our fiduciary obligations. The Covid-19 pandemic has brought this into harsh reality more than ever.

In South Africa, we’ve tended not to engage comprehensively with the full, investable universe available to trustees. This is unlike internationally, where for some time now, retirement funds have been investing in private debt (or unlisted credit) and impact investing (also known as responsible investing or ESG investing) – as ways to provide fruitful returns over the long term for their fund members, while benefitting society and the environment.

What has led trustees to favouring more impactful forms of investing?
Prior to the Covid-19 pandemic, many fiduciaries and other allocators of capital were considering alternative investments from as far back as 2012, where people were talking about the US Fed’s quantitative easing programme. At the time we asked ourselves “What are the risks associated with QE and what are the unintended consequences?”

With the fed pumping liquidity into the markets, asset prices were all going up, so we were concerned about whether it was appropriate to have 100% of our clients’ funds in public (listed) markets. Were there not other avenues to explore to help diversify away that risk?

Furthermore, markets had become increasingly ‘short-termist’ in their behaviour, and reacted to every single bit of news from Donald Trump and trade wars to China, which created volatility in the markets and discomfort. And this is when a long-term view becomes the safer option, where your capital is locked safely away, and then you can’t take short-term action and erode the value of your funds through constant switching and bad judgement, spurred on by excess noise in the markets.

A powerful diversifier
In private (alternative or unlisted) markets, diversification is just about the only ‘free lunch’ you can ever hope to get. It really makes sense in this low-return environment to be allocating more to private markets. These asset classes are all long-dated and inflation sensitive and will match the liabilities of many retirement funds or other long-term investors.

Invest for life not retirement
We should also be investing for life expectancy, instead of retirement – because longevity is another major risk we underestimate. Life expectancy is improving globally and we are all living for much longer than our grandparents were. We need additional sources of alpha to see us through the longer time horizon.

Coming back to fiduciary duty, it is our duty to exploit (or at least consider exploiting) the illiquidity premium (compensation that you get when you invest in a share that cannot easily be converted into cash) to enhance returns for those members with a long term investment horizon, who really need it. For perspective, consider that there was a time when equities were considered to be ‘alternative’, so people would frequently put all their money in bonds. Similarly, today alternatives are no longer considerate ‘alternative’ but have started becoming more ‘mainstream’.

Private debt, corporate debt, private equity and impact investing all play a big role here.

As a collective we have to invest for impact
The time is ripe for a more innovative approach to determine how your retirement fund can be diversified, and at the same time, save jobs and ignite the economy.

Private debt, for instance, is a good diversifier, returns are fairly stable and they are also inflation protected. But here you have to realise that you are in for the long-haul, so you must have a long-term investment horizon for this asset class. And generally speaking, the long-term horizon of your average retirement fund suits this perfectly.

So a key question is: do you have the right asset manager who understands both your needs and the investable universe to select from, making it a workable partnership that can yield real fruits? You also have to understand and quantify the risks, and select an experienced asset management partner who has a robust risk management process in place, who can navigate the complexity and make the right judgement calls.

The world has changed since Covid-19; we need to think differently
Fundamentally we have to change our mindsets. Now more than ever in a Covid-19 world, we have to consider the bigger picture, the long-term perspective, and allow our members to benefit from the higher returns one can get from investing responsibly. You can get involved in projects that give you excellent returns – such as our Investors’ Legacy range – where you’re not just making a good return, but you’re actually making a meaningful difference to the economy in a lasting and impactful way.

Investing in real assets not only carries higher returns and greater diversification, but aids economic transformation through job preservation and creation. Responsible investing or impact investing does not mean forfeiting attractive returns. That is a myth that must be instantly dispelled. You can have both social and financial returns and there is plenty of research that confirms this.

Ultimately, we should not only look at impact investing from a returns point of view, but we should look at how we can revive and grow the economy – it should be an argument about sustainability.

#People matter. Every job counts.

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