Unwise pension investments are a threat to social security

For the second year running, pension schemes are holding their annual general meetings (AGMs) against a backdrop of poor performance at the Nairobi Securities Exchange (NSE).

This means that pension schemes with huge exposure on quoted equities have suffered massive capital losses in the financial year 2015/16.

Pension scheme trustees should therefore seek a better appreciation of the investment environment with a view to developing robust investment policies that significantly diversify portfolio risks.

The volatility of returns on equity investments has forced pension trustees to turn their focus on properties to try to cushion their members against short-term capital erosion. However, the property market bubble that was witnessed in Kenya in the last decade is fast dissipating.

Pundits are pointing accusing fingers at the proceeds of the piracy menace that engulfed the Indian Ocean a couple of years ago, and illicit trade and money laundering associated with the collapsed state of Somali, as the key drivers of the property boom in Kenya.

With relative stability in the Horn of Africa, and improved maritime surveillance, the fortunes have nosedived.

Stuck with huge investments and dead capital, property developers are now frantically looking for alternative buyers from the legitimate sectors of the economy.

The corporate sector in Kenya has generally reported low profits this past year, rendering most players unable to prioritise property purchases over competing demands for financing. Pension schemes have stepped in to fill this gap, often making uncritical investment choices.

The pension trustees, who are the final decision makers on investment matters, have viciously moved in to extract private benefits.

Investment advisers, administrators and actuaries find themselves helplessly standing by as the rapacious trustees make selfish sub-optimal decisions that destroy life-time savings of members. It is a painful story of adverse selection, moral hazard, and outright corporate shirking, driven by raw greed.

The logic of investing in property to cushion pension funds from capital losses arising from market volatility is plausible. But the manner in which trustees prepare for, and execute the purchase is what determines whether members will benefit or lose from such a purchase.

First, trustees should understand that members are the owners of capital with the residual responsibility in decision making. Members have, however, delegated the day-to-day control of the affairs of the scheme to trustees, who are their agents.

The trustees’ decisions must therefore, be geared towards enhancing benefits accruing to members.

Sadly though, property vendors paint a very sorry picture of trustees bent on rent-seeking at the expense of owners of capital. The decision to purchase a property should be taken early, and asset maturity dates meticulously synchronised with it.

Pooling large sums of money into short-term equity investments often inflicts financial harm on pension funds. Besides being unable to iron out capital dents inflicted by market variability, short-term investments earn low interest incomes relative to long-term ones.

The penalties get harsher when the assets are redeemed prematurely, as many trustees often do to effect unplanned property purchases in return for commissions, ranging from five to 10 per cent of purchase price.

These commissions are part of the exaggerated property prices which trustees pay to vendors, over and above the asking price. Although good for stability of pension scheme funds, investment in property denies the scheme investable funds to diversify their portfolio, thus undermining interest income in the short run.

Besides, newly acquired properties take a while before they start generating rent incomes, while at the same time administrative costs keep accruing. Imprudent decisions have caused financial distress to pension schemes.

At macro level, sub-optimal decisions in the properties sector lead to market distortions, by creating higher prices than what market fundamentals can support. Consequently, corporate and individual investors are excluded from such markets due to incommensurate returns.

Mortgage financiers react to high property prices by increasing the cost of capital. Participation in the property market thus becomes a preserve of the cartels, and money launderers who can afford to throw good money after bad investments.

The rent-seeking behaviour and malfeasance among trustees inevitably leave members very vulnerable as their wealth creation objective, and social security are severely undermined.

Poor social security for retirees is a very strong motivator for employees to engage in corrupt behaviour as a way of cushioning themselves against old-age vulnerabilities.

There is therefore, need for capacity building and education in the pensions sector so that trustees and members appreciate the nature of their agency relationship, and the extent of fiduciary responsibilities.

In addition, trustees must engender consultations with members on major decisions. Finally, the Retirement Benefits Authority (RBA) should activate its supervisory mechanism to ensure compliance with statutory investment framework, and tenets of good corporate governance.