Asset Diversification for Retirement Benefits Schemes

By Cytonn Investments / November 20, 2019 | 2:08 pm



Retirement Benefits Scheme

Every Retirement Benefits Scheme strives to get as high returns as possible for its members every year in order to ensure they get to live a comfortable life in retirement. To achieve this, schemes diversify their assets in a bid to minimize risk while still maximizing returns.

Asset diversification involves the different asset classes in which you can allocate your money and expect a return. The saying goes “Do not put all your eggs in one basket” but you have to know which baskets are available and just how many eggs you should place in each. The same logic applies to Retirement Benefits Schemes.

To understand asset diversification better, we look at the investment guidelines under the Retirement Benefits Authority (RBA) regulations, which are tabulated under Table G in the regulations. The table provides maximum percentages of investments allowed for each category of asset class permitted by the Authority. It is summarized in the table below:

According to RBA industry report of 2018, schemes in Kenya invested up to 39.41 percent in government securities while average investments in quoted equities stood at 17.27 percent. The high allocation towards government securities is most likely because they have such low risk.

That said, in order to get higher returns, schemes need to consider other options such as real estate and private equity which are outside the traditional asset classes category. The graph below shows the rate of returns of various assets over 5 years:

Real estate as an asset class in Kenya has recorded the best return over the last 5-years averaging over 20.1 percent per annum compared to 1.9 percent, 6.4 percent and 9.2 percent for equities, 5-year government bond, and 91-day treasury bill respectively. In the year 2016, real estate recorded returns of 25.8 percent during the year.

It is common for retirement benefits scheme to invest their members’ funds in traditional asset classes year in year out without exploring other options the markets offer. However, by doing so, they are robbing their clients of possible returns. Real estate is not the only alternative (non-traditional) investment category. We also have private equity and derivatives. Diversification into alternative asset classes means taking on slightly more risk but this improves the rate of return.

Other factors to consider other than returns in asset allocation and diversification include:

  1. Age profile – The average age of the members of a retirement benefits scheme has a considerable effect on the kind of investment a scheme can make. If the majority of them are nearing their retirement age, then it would not be advisable to invest in real estate heavily as the scheme will need cash for payouts soon and real estate is not quickly convertible to cash. Similarly, such a scheme should not invest heavily in stocks as they are volatile and, in the event that stocks do not do well, they may not have enough time to recover before the members start demanding for their retirement lump sums.
  1. Capability – Capability refers to the ability of a retirement benefits scheme to invest and this is largely driven by scheme size. A relatively small occupational retirement benefits scheme intending to invest in real estate may need to join an umbrella scheme in order to access the capital-intensive real estate market. It is prudent to always do a proper background on any umbrella scheme before joining to ensure you are putting your employees’ money in a safe and stable institution.
  1. Research and Guidance – It is important to conduct detailed research into your chosen market. You should also monitor the performance of your asset class in relation to other industries in the market and what is likely to happen when the asset class does not perform as the past suggests. This all makes your investments more worthwhile. The scheme needs to come up with proper investment road maps and contingency plans.

Ultimately, investments of a retirement benefits scheme are guided by the investment policy of a scheme which indicates the proportions that should be invested in each asset class and the approach to take, whether conservative, moderate or aggressive. Before joining a scheme, ensure it matches your goals and always verify any information you get from your fund manager.

Above all, remember that asset diversification does not mean moving all your money to assets with high returns such as real estate. Instead, it is about spreading risk. It means investing some of the scheme funds in safer traditional classes and some of it in high return alternative investments so as to spread the risk and meet your target returns.

Read Also: Taxation of Retirement Benefits Schemes







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