Marginal diversification benefits of private equity fund of funds in South African pension fund

Abstract

The revised Regulation 28 of section 36 of the South African Pension Fund Act (no 24 of 1956) explicitly allowed and increased the maximum allowed private equity for a South African pension funds from 2.5% to 10%, effective 1 July 2011 (National Treasury, 2011). Four years later, there has not been a meaningful increase of private equity exposure in the South African (SA) pension funds (KPMG & SAVCA, 2015). In contrast, when Regulation 28 was revised in 2011 to increase the maximum allowed allocation to global assets in SA pension funds from 15% to 25%, most pension fund key decision makers were quick to increase and maximise their strategic and tactical allocations to global assets, respectively. Bradfield and Munro (2011) also quantitatively confirmed that global equities and bonds introduced significant diversification benefits to SA pension funds. The main objective of this study was to quantitatively determine whether SA private equity fund of funds introduces significant diversification benefits to SA pension funds. Diversification was broken into upside potential, downside risk, downside-risk adjusted and pairwise returns association. The secondary objective was to qualitatively assess whether SA pension fund managers were objectively assessing private equity. These included illiquidity risk, minimum investments and depth of private equity research. The quantitative research methodology used quarterly asset allocation and returns data from nine asset classes. A control strategic portfolio and ten other strategic portfolios with increasing levels of private equity exposure were constructed. These portfolios were then tested for statistical evidence of improved diversification. A qualitative approach in form of exploratory, 15 semi-structured interviews was used to contextualise the quantitative results. The quantitative results showed statistical evidence that SA private equity has better pair-wise diversification properties than SA listed equities and SA property relative to the asset classes in a typical SA pension fund. However, there was no statistical evidence suggesting that 10% allocation to SA private equity fund of funds results in increased diversification for a SA pension fund. The qualitative findings showed that lack of investment into private equity by SA pension fund managers has not been based on objective assessments of private equity