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Though the Nigerian Pension Fund Assets experienced a remarkable increase of 16.14% in 2016 (i.e. from N5.30trillion in December 2015 to N6.16trillion in December 2016), its purchasing power, real rate of return and relevance as a buffer for future retirees remains a major topic of debate for industry observers.
Similarly, the Pensions Act amendment in 2014 heralded several endowing transformations such as upward review of minimum contribution rate, tax on withdrawal of voluntary contributions and punishments for defaulting employers, but it failed to mitigate the following key risks:
Real value risks: The purchasing power of future pensioners is significantly threatened by high inflation rates and unimpressive returns on their Retirement Savings Accounts (RSAs). A recent article in the Journal of Economics and Sustainable Development, titled “Can Nigerian RSAs beat Inflation?” featured an assessment of ten major Nigerian pension managers for eight years (January2007 to December 2014) and it revealed an average loss of 312 basis points (net of inflation) during the period. Granted that recent segregation of pension funds into Fund I, II, III in April 2017 by Pencom was worth celebrating due to its expansion of categories and limits of asset classes, some industry watchershowever, are not entirely convinced of its ability to yield a shortor medium term improvement because of the currentmix (76% government bonds and treasuries) of total pension assets.
Systemic and contagion risk: The exceptionally high contagion risk in Nigeria’s pension industry stems from the nationalistic standpoint of Pencom’s policies. Specifically, pension fund custodians (commercial banks) are domiciled in a financial services system that is remarkably exposed to a volatile oil and gas industry. At the same time, the FGN Bonds (the predominant asset class) is issued in “Naira”, thereby adding a layer of currency concentration risk to existing contagion risk. The above loop creates a double-faced challenge (from pension custodians and asset allocation) in event of an economic crisis.
Currency risk: To the extent that Nigeria remains an import driven economy, devaluation of the Naira would always erode the purchasing power of pension beneficiaries. As at June 2016, over 97% of total pension assets were invested locally. Consequently, the purchasing power of N5.729 trillion pension assets in June 2016 was eroded by 75% due to devaluation of Naira over the past twelve months. Viewed differently, the total pension assets of N6.493 trillion as stated in Pencom’s most recent report (April 2017 report) would have been worth $32.467 billion (N200/$1) instead of $18.553billion (N350/$1) if Naira was stable over the past twelve months.
It is particularly noteworthy that similar depreciations consistently played out almost every decade in the past 30 years i.e. N0.9/$ from late 70s to early 80s, N17/$ in 1993, N85/$ between 1994 to 2004, N147/$ to 164/$ from 2004 to 2014 and about N200/$ to N365/$(depending on source and purpose of fund) from 2014 to date. The undoubtedly trend explains the reason for extensive ruin amongst pensioners.
Sovereign risk: According to Pencom, the total pension fund assets as at March 2017 was N6.415 trillion of which N4.875 trillion (76%) was invested in government bonds and treasuries. Taking this into account as well as Nigeria’s high debt profile, the sovereign risk factors for local pension assets seems amplified, likewise the probability of default, loan restructuring and rating downgrade.
If Nigeria is faced with a rating downgrade to “below investment grade status”, about 76% of the aggregate pension assets portfolio would automatically become junk bonds. If the downgrade was as a result of a credit crisis, several people would lose their jobs while their pension assets (a buffer asset class) would concurrently shed value. In such scenario, any attempt to resuscitate the economy through expansionary monetary policies would exacerbateinflation andfurther weakenthe purchasing power of pension assets- thereby creating a double whammy impact.
In consideration of the above, the April 2017 amendments by Pencom was a needed development because it enhanced investment options, recognized pension contributors’ demographics and considered the diverse risk appetites of different generations of beneficiaries. However, the transaction cost of rebalancing the existing N6.493 trillion portfolios may severely impact returns in the short term. The intricacies of the above and other diversification methodologies would be best expounded in a sequel to this article.
To this end, it is recommended that Pencom collaborates with the CBN to dollarize a portion of the total pension assets without recourse to existing foreign exchange windows (to avoid exacerbation of demand). Other recommended policy initiatives include; right to “purchase a percentage” of excess crude oil dollars from CBN, authorization of PFA’s (under the supervision of CBN and Pencom) to engage in asset swaps with potential foreign investors in Nigeria’s ECM and DCM, authorization to engage in currency swaps with foreign investors, right of first-refusal on dollar proceeds that emanates from non-oil sectors dominated by pension fund investments etc.
Lastly, Pencom may need to consider additional upward review of category limits for foreign bonds and supranational investments toexpedite diversification anddampening of sovereign and contagion risks.
Kingsley Mbah FCA CFA
