Fragmented Funds, Untapped Futures: East Africa’s Informal Sector Pension Puzzle
The current pension landscape within East Africa can be akin to a small square blanket during a cold winter night – little coverage and unsatisfactory returns. While formal sector workers can access pension schemes, the vast majority employed in the informal sector are excluded, missing out on the benefits of retirement savings and leaving much of the economy untapped for collective resource pooling. Such is the case in Uganda and Tanzania, where the informal sector accounts for over 50% and 47% of GDP, respectively, while the informal sector in Kenya accounts for 32% of GDP. Kenya leads East Africa with a coverage ratio of 20% workers covered from the total workforce, with Rwanda and Tanzania behind at 10%. Employer-based investment plans leave the members of the gig economy like self-employed freelancers, inaccessible.
Additionally, pension funds face a challenge in diversifying investments beyond traditional assets like government bonds due to underdeveloped capital markets and the inertia of fund directors to explore alternative investments. Over 70% of retirement industry assets are held in government bonds due to seemingly attractive interest rates and low associated risk levels. However, there is a growing interest in exploring new investment opportunities, particularly infrastructure, private equity and real estate. While private equity is on the rise within the region, participation is dominated by foreign capital seeking exposure to regional markets as opposed to local institutional investors like retirement funds. Private equity allocation stands at around 5%, while listed equity allocations range from 0-30% across the region. Moreover, pension funds maintain a substantial cash position due to their perceived safety, despite low interest rates.
This article aims to break down the region's retirement investment scene, explore the inclusion of the informal sector, and offer guidance on diversifying funds using alternative assets.
A Glance at East Africa’s Current Pension Funding Terrain
Pension funds in East Africa are experiencing significant growth and are becoming more influential in the realms of local, long-term finance, and reaching a significant proportion of GDP. For example, in Kenya, pension fund assets are now worth 12% of GDP, equivalent to $15 billion. The growth can be attributed to an expanding formal sector, rising incomes and a young, growing population. This growth echoes across the region as Uganda’s 18.6% increase in the retirement benefits sector is now worth upwards of $6.9 billion – representing 12.2% of the nation’s GDP.
Moreover, regulatory reforms aimed at strengthening governance, promoting investment diversification, and enhancing transparency are contributing to the growth and stability of the pension sector. For instance, Kenya's Retirement Benefits Authority (RBA) has introduced regulations allowing pension funds to invest up to 10% of their assets in infrastructure, recognising it as a distinct asset class.
In the third quarter of 2024, pension fund returns fell to 0.4% due to poor returns in fixed-income assets - bonds. Despite the low return, pension funds remained above the quarterly inflation rate of -0.1%, and the funds’ return of 17.3% to September beat the annual inflation rate of 3.6%. When the return fails to exceed the inflation rate, long-term savers experience a deterioration of the value of their savings, which, when compounded over time, negatively affects future payouts to the fund beneficiaries. The overexposure to treasury bills due to the fund manager’s conservative approach works to the detriment of the pension pot when returns from fixed-income assets are not up to par. This further emphasises the need for diversification not only in the search for improved returns but also to hedge against the underperformance of assets under management.
A key characteristic of pension funds in the region is that they are highly fragmented. Fragmentation refers to the existence of numerous, often small, pension schemes within a market, which can lead to inefficiencies and challenges in investment and management. Kenya has 1,300 separate pension funds, most of them tiny, single company plans. This leads to limited investment opportunities as small funds may not have the flexibility to diversify from high yielding treasury bills. Fragmentation also prevents economies of scale via increased administration costs and a reduction in pension benefits. The formation of associations like the Kenya Pension Funds Investment Consortium (KEPFIC) is an attempt to overcome market segmentation. KEPFIC brings together pension schemes so they can make long-term infrastructure and alternative asset investments in the region.
Informal Sector Growth
The informal sector in East Africa is massive. unstructured means of employment within the young but bustling economies of EA have resulted in the surge of a large informal sector. Employment within the gig economy accounts for 91.1% of the total population above the age of 15, with Uganda having the highest proportion at 93.7%. There is a common misconception that extending pension schemes to the informal sector equates to providing retirement schemes for the low-paid. Meanwhile, the informal sector experiences income heterogeneity, accommodating both low- and high-paid individuals. Therefore, the differences between the formal and informal sectors, such as income irregularity and employer contributions, demand different design approaches if the pension system is to benefit the informal sector. Key aspects that needs to be addressed if the current pension frontier is to be extended to the hidden economy include irregularity of identification, income variability, contribution matching and incentives, lack of access to financial services infrastructure and preservation.
In Kenya, the Mbao scheme is a voluntary retirement savings plan accessible to individuals over 18 with a national ID or passport. It is mainly targeted at Jua Kali labourers – small scale craft or artisanal workers – without access to occupational pension schemes. Benefits are tax-free unless they exceed the maximum exemption limit of $2000 per month. Mbao is distributed and managed via mobile money platforms M-PESA and Airtel Money. With only 100,000 active members, the fund only penetrates 1% of a 12 million informal population. The biggest barriers facing the adoption of the pension plan are a limited capital base and high costs of administration.
Uganda has two similar schemes: The Mazima Voluntary Individual Retirement Benefits Scheme (MVIRBS) was licensed by the Uganda Retirement Benefits Regulatory Authority (URBRA) in 2016, and the Kampala City Traders Association (KACITA) Retirement Benefits Scheme. Both schemes aim to make retirement savings more accessible to the informal sector. The MVIRBS has also partnered with various stakeholders to distribute its pension plans. MVIRBS has a total of 1,900 members, – shy of 1% of the informal population. Like Mbao Pension Plan in Kenya, the single biggest challenge is low uptake and awareness with both cases highlighting the importance of financial literacy. Initiatives to increase the usage of pension offerings should be paired with financial capability programs geared at increasing the financial capability of the consumer.
Asset Diversification
Alternative assets include private equity (PE), infrastructure, real estate, hedge funds, and commodities, among others and fall outside conventional asset classes. They are typically less liquid and more complex but often offer higher returns and better diversification opportunities for long-term investors. In East Africa, where pension funds have historically relied heavily on government bonds and listed equities, alternative assets represent an untapped avenue for achieving stronger portfolio performance. Alternative asset classes tend to yield better returns but the success of the process requires knowledgeable fund directors to expose the pension funds to more investment risk.
In addition, PE often has a long-term investment horizon which aligns well with the long-term liabilities of pension funds, allowing for patient capital that can generate sustainable growth for the investee companies. Some assets, such as real estate, can act as a hedge against inflation as their value tends to increase with the general price level, thus protecting investors against the erosion of purchasing power.
However, alternative investments are inherently illiquid due to the long-term commitments that tie up investors’ capital until a successful exit of the investment. This is unlike public equities, which are traded on stock markets and can be bought or sold instantly. Consequently, this illiquidity presents a significant challenge, as fund managers often need to balance long-term growth with meeting short-term liabilities, such as payouts to retirees.
Conclusion
The pension landscape in East Africa faces dual challenges of low coverage and poor returns. While formal sector workers benefit from pension schemes, the informal sector remains largely excluded. Promising initiatives like Kenya’s Mbao Pension Plan and Uganda’s Mazima Scheme face barriers such as low uptake and financial literacy gaps. Bridging this gap requires innovative solutions tailored to informal workers, including mobile technology and flexible contributions.
To transform East Africa’s pensions from a small square blanket that leaves much uncovered, the region must embrace a more diversified investment strategy. By moving beyond the comfort of traditional assets and venturing into alternative investments such as PE and infrastructure, pension pools can secure higher returns and greater resilience against inflation and volatility. A broader, more inclusive plan – paired with continued supportive regulatory reform and enhanced expertise – can provide a retirement blanket that wraps around both formal and informal workers, ensuring a more robust and sustainable financial future for all.
