Nigerian Pension Funds: Growing Younger, Yet Less Adventurous

This Insight is a synopsis of how the $24bln Nigerian pension industry has evolved both in terms of size, demographic characteristics of the contributors and the funds asset allocation dynamics. While there has been a demographic shift towards younger contributors, the asset allocation of the funds is yet to reflect this reality. Is there scarcity of assets that fit well with younger beneficiary pool or is it just that pension fund administrators are constrained by regulation to be extremely conservative? We look at this along four lines of thought.

Demographic Shifts in Membership Base

A total of 5.7 million people have been enrolled under the Nigerian pension scheme as at Oct 2013 (the latest publicly available information) with the Retirement Savings Account (RSA) active members accounting for 98% of the total. Membership has been growing at 15% compound annual growth rate since 2007. The population of RSA contributors is growing younger as the under 30 population fuels the membership growth. The percentage of contributors below 30 years reached 33% in 2013 up from 21% in 2007. Given this strong growth pipeline, we foresee the under 30 years to be the single largest bracket by 2015 ahead of 30 – 40 years bracket. This will be driven by Nigeria’s extremely youthful population structure.  It is worth noting that it took the under 30s just 4 years to surpass the membership base of 41- 50 years bracket but we reckon it will take much longer (6 years on our estimate) to overtake the 30 – 40 years bracket due to the reinforcing effect of the under 30s as they grow older. Hence, our 2015 projection.

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Asset Size:

So lets move to the cash. As at October 2013, total Pension Fund Under Management was NGN3.8trilllion ($24billion) out of which the RSA Active Funds took a cut of NGN2.4trillion ($14billion). The RSA Active Fund has grown at a 40% compound annual growth rate over the last 6 years which implies the fund has been doubling in size every other year. The potential growth of this fund is still very much underexplored given four drivers. First, Nigeria has about 60million work-force population implying that less than 10% of potential members currently contribute to this fund. Ongoing reform on extending pension fund contribution to firms with at least 3 workers from 5 workers currently also means that SME workers will increasingly be captured in this scheme. Second, Nigeria’s positive per capita income growth expectation means that contribution per head will jump over time. This will be “turbo-charged” further as the 2004 Pension Reform Act is being reviewed to increase the pension contribution to 12% by employers and 8% by employees (effectively 20%) from 7.5% contribution each (effectively 15%). Third, reduction in the current unemployment rate of 24% means more hands are likely to contribute to this pot (Well, you think unemployment will keep rising? Sorry, we do not think so. Activities of real sector-focused investment management firms like Sart and her sister companies will surely contribute to reducing that figure one step at a time). Finally, the interaction of the above three factors will magnify the growth of the fund over the next decade. The most piercing question to the PFAs is “Where will these billions of dollars be invested at a positive real return without fuelling asset bubble? Obviously, investing 85% of a less than 30 years old man’s retirement funds (who has additional 30 years ahead of him before retirement) in bonds and money market instruments is not a sustainable strategy for real-return generation. So lets see the current asset allocation of the RSA Active Funds and where this might tilt in the future.

Asset Allocation:

Conservative posture defines the current asset allocation of Nigerian pension fund. As at Oct 2013, about 85% of RSA Active Funds was invested in government securities (Federal and State Government bonds, and T-Bills) and money market instruments. While regulatory limit is a strong determinant in pension fund asset allocation decision, the existing caps for alternative assets such as Private Equity Funds (5%), Infrastructure Fund (5%), Mutual Funds (20%) are still grossly under-tested. This tells one of two stories: PFA are extremely conservative or there are no real alternative assets worthy of investing in. Our bet is strongly on the latter story. Investment structures with attractive risk-return profile are still very paltry in number.

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Return Profile: 

Yes, the asset base has been growing impressively. However, that growth has been fueled materially by new contribution year in year out. The sheer size of unregistered members and younger contributors mean that New Contribution most likely will remain the key driver of growth. But that growth driver will soft-pedal at some point and a key driver of growth will be the value-add by fund mangers in generating return on investment.

How are they doing right now? The beauty of fixed income instrument, especially sovereign instruments where 72% of Nigerian pension assets is invested, is that a fund manager just buys the instrument at a yield he likes. He can decide to go to sleep and earn the periodic coupon until maturity. The risk is, if inflation rate surges, the assets may actually throw up a negative real return. The return from sovereign instruments is further eroded by fee/charges of 2% – 3%. A waterfall of 2011 and 2010 Portfolio Growth Drivers below gives a vivid picture of where the growth is coming from.

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The summary here is simple. Yes the Fund Under Management has been growing at steep rate. This has been  driven largely by new contribution and not the return on investment. Factually, there are have been more years of sub-inflation rate of return on the RSA Active Funds in the pension industry history. The obvious impact of this sub-inflation performance has always been dwarfed by report of double digits growth in Fund Under Management riding on the back of strong new contribution. Effectively, the purchasing power of the retirement funds of those actively working is eroding. This underscores the fundamental need to search, structure, develop and invest in alternative asset classes that have the potential to beat inflation sustainably. The beauty here is the opportunity to create real value by connecting with real economic activities vie direct and indirect funding exposure while generating returns that sustainably beat inflation rate. The ripples are enormous and value will reverberates across diverse sectors. Think of infrastructure, agriculture, SMEs, manufacturing, healthcare, FMCGs and the attendant job creating opportunities.

So, let go back to work to do this. In Sart, this is essentially what we do, creating formidable investment platforms that connect with and add value to the real economy while also providing investors (institutional and individual) direct and indirect exposure opportunities to sustainably generate alpha. Yes, we are in the business of alpha cultivation.

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