Prescribed assets a ‘bad call’

Balancing the books: Trade and Industry Minister Ebrahim Patel would like retirement funds to invest to promote growth. (David Harrison)

Balancing the books: Trade and Industry Minister Ebrahim Patel would like retirement funds to invest to promote growth. (David Harrison)

As the country’s state-owned entities (SOEs) buckle under the weight of their debt — and reap the results of years of mismanagement and corruption — the ANC election manifesto’s proposal on prescribed assets looms ever larger as a means to rescue them.

Power utility Eskom will run out of cash by October, Denel was unable to pay full salaries to staff this week until rescued by “a lender”, and the SABC cannot pay creditors such as the City of Johannesburg, according to a Sunday Times report.

Alexander Forbes Investments warned during a presentation this week of the negative consequences asset prescription could have, not only on pension outcomes but also on the wider economy.

Asset prescription would force entities such as pension funds to invest in certain assets, such as parastatal bonds. The negative consequences would not only be felt by pension fund members but also affect foreign direct investment in South Africa, as well as hamper the country’s ability to fund its current account deficit, said Isaah Mhlanga, executive chief economist at Alexander Forbes.

The government has not given any indication that it has imminent plans to introduce prescribed assets, but recent comments by Trade and Industry Minister Ebrahim Patel, encouraging retirement funds to invest to promote growth, has been read as further support for the idea.

Patel’s comments, made at a conference held earlier this month by Batseta, the council for retirement funds, prompted the Association for Monitoring and Advocacy of Government Pensions to warn against the “disastrous” effect this policy could have.

The association represents members and pensioners of the largest fund in the country — the Government Employees Pension Fund (GEPF) — which holds almost R2-trillion on behalf of its members.

Asked after President Cyril Ramaphosa’s State of the Nation address last week how his comments related to the ANC’s position, Patel didn’t want to delve into “complex policy” debates in limited interview. But he did say that retirement funds, which manage about R4-trillion, have a huge pool of investable resources and, since their investment universe is South Africa, their investment performance largely tracks the local economy.

“[Pension fund] trustees’ role is to help ensure that the investment strategies that they support help to grow the economy,” said Patel. This was in the interests of their own members, “because they are not going to get … excellent returns, when the GDP [gross domestic product] is growing at a pedestrian rate”.

Retirement fund trustees need to think strategically about how they, as one of many players in the economy, help to boost growth, said Patel.

But he stressed that this was alongside their equally important role of protecting members’ funds. “It’s not [money] that is at the discretion of the state or at the discretion of the trustees, it’s money that you have to prudently invest — you’ve got to avoid looting of the money and you’ve got to avoid recklessness [with] the money.”

But moving from these discussions to the detail of developing policy was where the nuance comes in, he said.

Although no formal regulation is under discussion at government level, unease remains. Mhlanga said: “This is still discussed at a political party level, not at the government level, but we are concerned because the political party that is looking to introduce this is the ruling party.

“The financial sustainability of all these SOEs is quite dire,” he said, and is contributing to ongoing funding problems, with investors unwilling to lend them money.

In 2017 the country’s major SOEs redeemed more outstanding debt, of R13.7-billion, than new debt issued, of R12.6-billion, according to Alexander Forbes. In 2018 net debt issued by SOEs was R5.7-billion and this year’s forecast issuance is expected to be only fractionally higher than last year’s.

If private investors were forced to buy SOE bonds, this would force disinvestment from other assets such as equities, Mhlanga said. Prescription would also create an artificial demand for these assets and investors would be unlikely to earn returns sufficient to compensate for perceived risks.

At a macroeconomic level, foreign investors will not be subject to prescription, so they are going to vote with their feet, said Mhlanga. This could have balance of payments consequences, making it difficult for South Africa to fund its current account deficit as foreign investors take their money out the country, in turn driving currency weakness.

When it comes to ramifications for individual investors, namely pension fund members, prescription will result in reduced member confidence in the retirement system, said Janina Slawski, principal investment consultant at Alexander Forbes. It would also undermine existing reforms by the government aimed at getting people to save more for retirement, and may see more people opt to save outside the retirement system.

Responses from contribution fund members on the question of prescription have been negative, Slawski said, prompting “very, very scary conversations”, such as members asking employers to opt out of retirement funds, or reduce their contributions.

Under the apartheid regime, when international investors shunned South Africa, the state required pension funds to invest more than half their funds in prescribed assets.

The local industry is already required to comply with a certain level of prescription through regulation 28 of the Pension Funds Act. Regulation 28 limits the exposure funds can have to certain assets in the interests of protecting investors and ensuring sustainable returns. Exposure to equities, for instance, is limited to 75% and only 30% may be invested in offshore assets.

Slawski said, from an industry perspective, the regulation is “very workable in its current format” and in the case of local equities many are driven by offshore developments.

“You actually have wide exposure to international factors just by holding local equities,” she said.

If the government did decide to introduce asset prescription, amending regulation 28 would be a way to introduce this, said Senzo Langa, head of portfolio management at Alexander Forbes. Although it might not be at levels seen in the past, it could serve as a quick way of introducing the policy.

Alexander Forbes was strongly behind a different solution — positive incentives and structures that would promote investment in developmental assets, said Slawski.

The country already has some good examples, such as the Renewable Energy Independent Power Producer Procurement Programme. The tender process for the latter attracted almost R210-billion of investment.

Alexander Forbes said that other positive initiatives included the JSE’s recently launched listed green bonds, intended for the financing or refinancing of new or existing projects that have a positive environmental and climate benefit.

The JSE also announced the listing of infrastructure bonds in 2018. These “project bonds” will give institutional investors an opportunity to invest in infrastructure projects.

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