This is the first in a series of five articles, written by John Morris and Nick Malaczynski, on international investment by pension funds.
Last Sunday, July 13, was the second anniversary of the Reserve Bank's introduction of the asset swap programme.
This programme allows South African retirement funds to invest up to 10 percent of their members' assets overseas.
While individuals have begun investing some of their personal assets overseas during the last two weeks, very few people have examined what their retirement fund trustees have been doing with the much larger amounts of their money which are in their pension and provident funds.
In contrast to all of the interest and activity surrounding the July 1 relaxation of exchange controls for individuals, pension and provident fund trustees have for the most part ignored the opportunity to invest overseas.
While the reasons for this failure seem to vary from pension fund to pension fund, trustees all have the same duties under the Pension Funds Act to invest fund assets prudently.
This means that trustees must give consideration to overseas investment in carrying out their duties.
The Pension Funds Act requires the trustees of a pension fund to "act with due care and diligence" in managing the assets of the pension fund. This due-care standard requires the trustees to apply prudent investment practices to their investment decisions. Prudent investment includes diversifying the pension fund's assets to reduce risk, and seeking the best investments available to improve performance.
In the developed countries of North America, Europe, and Australasia, it is accepted as conventional wisdom that pension funds should diversify internationally in order to reduce risk and improve performance. The case for international diversification is even more compelling in South Africa.
In South Africa, our economy is less diverse than many of the developed nations, and therefore offers insufficient potential to fully diversify risk. It is difficult to invest in growth industries such as technology and health care. To invest in the best companies in these industries, pension funds will have to invest overseas.
In addition, both the Johannesburg Stock Exchange and the rand have become and will remain more volatile. The increased flows of capital into and out of South Africa, as a result of both the opening of our market and the relaxation of exchange controls, leave our market and currency subject to much greater volatility.
One of the ways for a pension fund to reduce the risk of this volatility is to invest overseas in other markets and other currencies.
There are those who suggest that instead of diversifying overseas, pension fund trustees should invest pension assets to create jobs and build infrastructure in South Africa. This thinking is at odds with the law which requires pension fund trustees to maximise the retirement benefits of pension fund members - rather than create jobs or build infrastructure.
Nevertheless, most of us would agree that pension funds and their trustees have the same civic responsibilities as other organisations and individuals. The solution to this dilemma probably rests in a compromise between the competing demands on trustees.
No one is suggesting that a pension fund should invest all of its assets overseas, or all of its assets in infrastructure projects. Either would be unacceptably risky and imprudent.
Instead, pension fund trustees can "act with due care and diligence" as the law requires while creating diversified portfolios which may include both international investment and infrastructure investment.
The responsibility rests with the trustees to determine what mix of investments is in the best interest of the members of the pension fund.
Where pension fund trustees are letting down their members is where they have failed fully to consider using international investment both to reduce the risk and improve the performance of the pension assets for which they are responsible. This failure by pension fund trustees is inconsistent with their due-care obligations.
John Morris and Nick Malaczynski are the managing director and chief institutional consultant of TriStar International Consulting Limited, a company which provides international investment consulting services to South African retirement funds.