The Prescribed Asset Debate: Risk and Opportunity
It is not yet clear what the ruling party or the government envisages as its final policy on boosting available finance from pension funds for economic growth stimulus, but options to allow, incentivise or even instruct pension funds to channel some of their investments into its infrastructure-led growth plan over the next decade is being investigated.
The chatter in policy forums, mentions in official documents and comment in the public domain has made South African savers nervous, due to the lack of clarity that surrounds the topic.
Will the government return to a practice of prescribed assets last seen under the Apartheid regime? Or will they, as stated by the head of the economic transformation committee of the ANC, Enoch Godongwana, simply tweak Regulation 28 of the Pension Fund Act to allow trustees of pension funds to voluntarily invest in profitable infrastructure projects?
In the meantime, investors are weary and uncertain. Fund managers are unsure of what the future holds and financial advisers are unclear on how to advise clients and assuage their fears.
“The first thing investors should realise is that, even if prescribed assets are implemented again the way they were under the previous regime, it would not apply to discretionary investments and only to pre-retirement savings products that are governed by Regulation 28 of the Pension Fund Act,” says Victoria Reuvers, managing director of Morningstar Investment Management SA. “Currently most investors have an allocation to government bonds in their regulation 28 compliant portfolio (typically between 15% to 40%), so if government implemented a prescribed minimum holding, you would increase this allocation in your portfolio.”
She also notes that even if investors are forced to buy government bonds, these investments would still generate a return, but the return could likely be below fair market value.
“Currently if you hold government bonds you get around a 9% yield, she says. The fact that fund managers are increasingly making up a larger percentage of the ownership of government bonds does give an indication that these bonds offer an attractive return in current market conditions.”
Bonds and infrastructure as investment opportunities
According to data from National Treasury the percentage of ownership of pension funds in government bonds might have gone down from a high of 46% in 2007 to its current level of 23,3%, but ownership by other financial institutions have been climbing steadily from a low of 6% in 2012, to around 16,8% as at June 2020. International investors own 30.6% and the banks make up a considerable chunk of the remainder at 22,1%.
In an uncertain world, the data supports the argument that government bonds at its current yields are a valuable inclusion in any investment portfolio.
Geordin Hill-Lewis, the DA’s Shadow Minister for Finance, argues that this is a short-sighted view to take.
“The reason why those bonds are giving a good return, is because the South African government is failing. Government has to pay a high interest rate to find money to borrow,” he says. “But will that argument work in a couple of years when we are facing a full-blown sovereign debt problem and SA has to go to the IMF for a bailout and has to renegotiate its debt repayments?”
With regards to infrastructure projects, the investment environment around the 2010 World Cup Soccer shows that when done right, it could provide good returns for investors.
Kevin Lings, chief economist at STANLIB, cites the success of unit trust funds that were specifically infrastructure-related at that time. “They became highly successful and were able to provide returns,” he says. “I have no doubt that if you set up a private sector infrastructure fund, you will find money being made available locally and also internationally – together with pension money. And this without changing Regulation 28.”
Ndabe Mkhize, the chief investment officer at the Eskom Pension and Provident Fund, recently penned an opinion piece on the attractiveness of infrastructure projects as an investment opportunity.
“The question is not why a South African pension fund would want to devote a bigger portion of its investment capability to infrastructure development. It is why not,” he says.
“For asset owners such as pension funds, which have assets of about R4.4-trillion under management, infrastructure development offers an attractive investment option: it satisfies a market demand, offers strong and predictable returns over time, risk can be mitigated in various ways, and it provides a way for investors to meet important environmental, social and governance (ESG) and impact-investing goals,” says Mkhize.
The opportunity does seem to exist. The risk, however, lies in the lack of policy clarity and how the final policies will be implemented.
“We need to clarify the outstanding issues with urgency,” advises Lings. “We need to move the country forward.”
Max du Preez, journalist, author and political analyst, believes the ANC understands the risk associated with using prescribed assets as a blunt instrument. Therefore, he does not see the need for any rash decisions by pension fund managers or its members. “Whatever happens it is going to happen very slowly.”
Reuvers says her advice to clients would be, first and foremost, to take a step back and do their best not to panic. “Don’t let the controversial headlines rattle your cage before knowing the facts. Secondly, remember that should prescribed assets be implemented, it would likely only affect a portion of your savings. And thirdly, it doesn’t mean that you would earn a zero return on the possibly affected portion,” she says.
Brian Butchart, managing director at Brenthurst Wealth Management agrees that panic is unnecessary, but advises individuals to consider a critical discussion with their financial advisor. “Especially for those over the age of 55 (qualifying age for most pension benefits),” he states in a commentary published on the company’s website. For investors above this age there are options to consider, such as drawing a lump sum in order to convert a portion into a living annuity. “In so doing, an investor can protect his/her savings, converting pre-retirement products governed by Regulation 28 to a post-retirement living annuity,” he says.
Lings advocates vigilance. “Investors and advisers should follow the debate and see if any risks are developing. If the policy options become destructive, it will be the responsibility of trustees and managers of pension funds to make the appropriate changes that will take account of those risks,” he says.
Sound familiar? This article was first published on Daily Maverick, 13 October, 2020.