The debate around prescribed assets grabs headlines from time to time, but when you cut through the hysteria there is largely a consensus that pension funds could be used to boost infrastructural development in South Africa. The important question is about how this would be done.
While the ANC’s 2019 manifesto spoke of an “investigation of the introduction of prescribed assets”, National Treasury has consistently stated that prescribed assets would not be introduced and retirement funds would not be coerced into investing in failing state-owned enterprises.
This does not mean that retirement funds should not consider investing in viable infrastructure projects. There are calls, even within the retirement industry, for pension funds to increase their exposure to unlisted infrastructure projects.
Infrastructure projects are excellent investment opportunities for pension funds, as long as the project is viable and delivers an above-inflation return.
All retirement funds already invest heavily into government bonds. This is in part due to the existing Regulation 28 of the Pension Funds Act which limits equity exposure to 75%, requiring bonds and listed property to make up the difference. However, South African government bonds have also delivered good returns for investors.
Janina Slawski, head of investments consulting at Alexander Forbes Investments, says the fear around prescribed assets is that pension funds will be forced to invest in state-owned-enterprises (SOE) with a potential lower investment return versus that sought by investors.
Previous implementation of prescribed assets
Prescribed assets are not new to South Africa, having been implemented by the national government from 1956 to 1986. During that time 53% of retirement-fund assets and 75% of government pension assets had to be invested into government and SOE bonds. These bonds paid returns well below inflation as a cheap source of funding for infrastructure development.
According to figures supplied by the Association for Savings and Investment (ASISA), prescribed assets in the 1980s paid returns of 13.5% compared to inflation of 14.5%, and in the 1970s, prescribed assets delivered only 7.3% compared to inflation of 11.3%.
Slawski explains that at the time funds were ‘defined benefit’, which meant the liability fell to employers to ensure members received their promised pensions. Members were largely protected from underperforming investments, because companies carried the losses.
Prior to 1996 the Government Employee Pension Fund (GEPF) ran a deficit and government pension obligations were funded by taxpayers. Slawski points out that today, most pension funds are ‘defined contribution’ and the benefit received at retirement depends on market performance (apart from the GEPF, which remains a defined-benefit fund).
If forced to invest in low-return assets, there would be a serious impact on the ability of South Africans to retire. Hence any discussion which forces funds to bail out failing SOEs is a non-starter.
However, Zamani Letjane, CEO of Akani Retirement Fund Administrators, South Africa’s biggest black-owned retirement administrator, believes there is an opportunity to use pension funds for economic development without reducing returns.
Infrastructure projects as an opportunity
Infrastructure projects are long-term investments with a predictable return profile. Asset managers could select infrastructure projects that they believe will both deliver a market-related return and provide for economic growth.
Letjane notes that while the ANC-led government has developed good legislation, the policy implementation has left a great deal to be desired, as evidenced by the failure of SOEs such as PRASA and Eskom.
“The government will do better if they partner with companies already active in certain sectors of the economy through public-private partnerships. There are black fund managers already in infrastructure investments. These companies, such as Mazi, Aluwani, Thirdway and Mergence, invest in the real economy through private equity funds, ” says Letjane.
“Government would do well to partner with these managers to foster economic transformation instead of relying on the big, established business all the time.”
Letjane adds that fund managers would never agree to simply handing cash to poorly managed SOEs.
“If government goes ahead and prescribes for the industry to invest in failing SOEs, this will lead to litigation. Funds will not be willing to give money to the government without their involvement in the process; this would be a recipe for disaster.”
Large institutional investors and government have already developed a database of projects with a value of R2.1 trillion for investment over the next few decades as part of the Sustainable Infrastructure Development Symposium (SIDS). These will focus on digital infrastructure, energy, transport, water and sanitation, agriculture, and human settlement.
The case for increased private equity exposure
Last week the Southern African Venture Capital and Private Equity Association (SAVCA) submitted proposals to increase the prudential limits to provide more funding for private equity. Regulation 28 places private equity in the same category as hedge funds. Currently up to 10% of funds may be either invested in hedge funds or private equity, with a combined exposure to both asset classes limited to 15%.
SAVCA argues that as private equity focuses on the real economy, offers pension funds attractive returns, and is uncorrelated to listed equities, it should be provided an independent asset class and gradually increase the private equity cap from 10% to 15%.
“We believe a case could be made for an even larger increase, however, pension funds will need to develop the skills to analyse the asset class and supply size may need to increase capacity,” says Letjane.
While Letjane and SAVCA believe the limit should be increased, Slawski argues this would increase the risk to members.
“This is already a huge allocation to an illiquid asset. The current environment is a stark reminder that there can be large unexpected payments out of retirement funds during times when companies are retrenching or going out of business. We do not necessarily see large additional investments going from retirement funds into unlisted infrastructure.”
The discussion around unleashing the power of the R6 trillion retirement pool to build the economy is an important one, but in order to explore the options without alarm and panic, we really need to drop the term “prescribed assets”.
What do you think? Should your retirement fund should be used for infrastructure development as long as it provides above-inflation returns?
This article first appeared in City Press.