With effect from July 2018, contributors to Nigeria’s contributory pension scheme (CPS) will now have options regarding how their contributions are invested and have the prerogative to direct their Pension Fund Administrators (PFAs) to invest their pension contributions in line with these options.
Since 2004, when the CPS was introduced, the pension contributions of active contributors (those still in service) have been managed by their respective PFAs in a Single Investment Fund with the PFA choosing the actual portfolio composition and investment instruments in line with the Regulations for Investment of Pension Funds issued by the National Pension Commission (PenCom).
With the new Multi-Fund Structure to be implemented from July 2018, three distinct Investment Funds will be available to active contributors called Fund I, Fund II, and Fund III, while the retirees managed by the PFAs will be placed in Fund IV. The core difference between the distinct Funds will be the amount of risk inherent in each fund driven by the minimum and maximum amounts of variable income instruments that each Fund can contain based on the Investment Regulations.
Essentially, RSA holders will be allowed to choose from these three funds and decide the amount of risk that they are willing to take in the management of their investment portfolios, in line with the Regulations.
Typically, when it comes to pension fund investments, the global best practice is for portfolios of different risk characteristics to be created and for investors to select the portfolios that align their risk appetites often driven by their age; level of income; liquidity needs, overall stock of investments, the level of diversification of their wealth and of course their past experience with investments that generally affects their risk appetite.
So, for example, the younger people are, the more likely they would have a higher appetite for and ability to take on higher levels of investment risk. This ensures that younger contributors who have a longer gestation period for their investments up to retirement can exercise their prerogative to be more aggressive about their pension contributions and possibly earn higher returns on their pensions over this longer period.
For example, a 25-year-old who just joins the CPS has in the maximum another 35 years to work and contribute, and so, should have the option to invest more aggressively than a 58-year-old who has just 2 years to retire. In the old arrangement, both the 25-year-old and the 58-year-old, and everyone in between them was placed in a Single Investment Fund that was invested in the exact same without recognizing the different risk appetites of RSA holders based on their age and other considerations.
Our CPS has now adopted this global best practice after fourteen years of implementation. From inception in 2004, we had anticipated that this day will come, and even in my book “Pension Fund Administration in Nigeria”, published in 2007, the imperative of multi-funds was discussed.
The only impediments to its implementation back then which I highlighted in my book were three-fold – 1) The need for us to transition from the old pension system to the new without creating too many changes that could confuse participants; 2) the depth of the financial markets and the dearth of financial instruments to accommodate the realities of a multi-fund structure; and 3) the low-level of financial literacy of most RSA holders that will affect their ability to make informed choices.
The third impediment still remains an issue that the industry regulators and operators need to pay attention to – ensuring that RSA holders understand the workings of the financial markets and underlying investment instruments so that they can make appropriate choices regarding the options available to them. For this to happen, the employees of the PFAs, especially the customer-facing employees in Sales, Relationship Management and Customer Service roles also need to improve their working knowledge of the financial markets and investment instruments so that they can properly educate and guide their customers who will be making these enquiries.
We all need a healthy dose of both pension literacy – understanding the workings of the CPS and the Multi-Fund Structure as well as a dose of Financial Literacy – plus a broader understanding of personal financial planning, financial markets, investment instruments and investment management.
The new multi-fund structure will commence in July 2018 and PFAs will have up to 6 months after the commencement to restructure their portfolios to be compliant with the new regulations. According to the Regulations, the maximum exposure to variable income instruments will be as follows – Fund 1: 75%; Fund II: 55%; Fund III 20% and Fund IV – Retiree Fund:10%. There will also be minimum exposures to variable income instruments – Fund I: 20%; Fund II: 10%; Fund III: 5% and Fund IV – Retiree Fund: 0%.
Both Funds I and II must have a minimum of 2.5% of their portfolio invested in Infrastructure Funds, Private Equity Funds and Real Estate Investment Funds. Variable income instruments are typically riskier than fixed income instruments like Treasury Bills, Government Bonds and Bank Placements and offer a higher potential reward.
This means that Fund I is the most aggressive fund, while Fund IV is the most conservative fund. At the inception, RSA holders who are 49 years and below will be placed in Fund II, 50 and above in Fund III and retirees will be placed in Fund IV by default. Thereafter, Fund I will only be available on request by RSA holders who are below 50 years old, and RSA holders can switch from one Fund to another subject to these restrictions and other regulations.
Overall, the new multi-fund structure is a great innovation in our CPS and one that will ensure that our investment decisions are better aligned to the realistic needs of contributors. However, from all the investment jargons that I have used, it is imperative that RSA holders are better educated about financial markets and instruments and that the client-facing staff of PFAs are also educated and equipped to also educate them. With the proper investment in education and enlightenment, the multi-funds will be no doubt a huge success!