27four Investment Managers
18th February 2019
Dwindling state finances puts prescribed assets back on the ANC’s radar
SA only has to look at Zimbabwe to see the harmful effects of such investment
Nobody likes being told what to do, least of all fund managers incentivised by performance fees to chase returns. When the spectre of prescribed assets returned to the national dialogue in 2017, it received a predictable smack-down from all the usual suspects, and was then drowned out in the noise of state-capture revelations.
All went back to normal on the investment front until the recent release of the ANC election manifesto, which included wording to the effect that the ANC would be exploring the possibility of prescribing which assets financial institutions must hold.
Prescription of assets was abolished 30 years ago, after it was used to prop up government finances in the last days of the apartheid government. So why is the ANC looking at this now?
The truth is that government finances have been backed into a corner. After a decade of overspending, expanding the size of the government and corruption at state-owned enterprises (SOEs), the fiscus no longer has the luxury of choice. There is a limit to how many commitments and guarantees can be given before the market no longer believes them, and time is running out before SA’s finances find themselves in this position.
In a country thirsty for capital, the financial sector is almost too juicy to resist; the savings pool alone is close to R8-trillion. But it is not just savings the ANC has its eye on. The wording of the party’s manifesto refers to “financial institutions”, which would possibly also extend to non-linked insurance companies and even banks as targets for prescription.
The most visible prescription that exists in SA is regulation 28 of the Pension Funds Act, which sets out prudential limits on what can and can’t be invested in by South Africans saving for retirement. This is mostly set out as maximum limits for various asset classes, with the obvious exception that the majority of assets have to be invested in SA.
In a global context this is fairly unusual, where most developed countries place responsibility on boards of trustees of pension funds to invest appropriately.
SA and most other African countries have taken the opposite approach, in many cases severely limiting or prohibiting investments abroad for fear of capital flight. Most SA pension funds have used their maximum offshore allowances in recent years, and it may well be that the prescribed minimum local investment has already resulted in market distortions.
Indeed, an even bigger prescription currently restricts the country’s largest pension fund, the R1.8-trillion Government Employees Pension Fund (GEPF). The GEPF is not subject to regulation 28 but has its own even more onerous prescription to invest locally. It has been reported that the GEPF would like to see the prescription loosened to allow it to invest more offshore.
The GEPF’s most recent reported surplus of 15% of assets over liabilities must be very attractive to the government as a potential source of investment, and it is not inconceivable that a bargain may be struck to enable the GEPF to invest more risky assets offshore while committing to direct more debt investments to the government or SOEs.
We do not have to look far to see examples of asset-class prescription over and above restrictions on investing away from home. Zimbabwe and Namibia have used prescription to some extent to try to direct flows of private capital. Zimbabwe, in particular, is an interesting case study, where prescription severely distorted the price of prescribed assets to the point where they had to be held by local pension funds but yielded virtually no return for investors.
The two sides of the coin were that it created local demand but in doing so distorted the market, making these investments unattractive to foreigners. Once the limit of local investors is reached there is no further market for the assets.
The other driver towards prescription is the very real disconnect between high-flying fund managers making hard-nosed investment decisions and the fact that many parts of SA are starved of investment. It has been said all too often that there is a First World and a Third World SA, and it is this dichotomy the investment industry must address if it is to stave off the worst of prescription.
The investment industry must work harder to invest in a way that is clearly seen to benefit South Africans while still achieving returns, to repel such interventions. Recent trends towards impact investing, transformative private equity and public-private partnerships demonstrate that such initiatives can work, but more needs to be done.
When considering where to get capital at below-market rates, development finance institutions (DFIs) always come to mind. Unfortunately, given SA’s status as a middle-income country (despite the obvious inequality), most foreign DFIs do not consider SA’s need to be as urgent as other countries. This means that to a large extent significant capital from foreign DFIs is off the table. There are several local DFIs, but since these are already owned by the government the argument is somewhat circular. The only area where these local institutions may create capacity is through the sale of long-held assets, to free up capital for fresh local investment.
In summary, prescription is not about to happen. It has been under consideration by the ANC for years and is still described in an exploratory fashion; there are clearly no firm plans. That said, the drivers of the debate are much more pressing. Government finances are stretched and solutions must be found. Similarly, in a country with such vast inequality, large capital pools will not be allowed to go untouched forever, unless more concrete steps are taken to demonstrate their contribution to transforming SA for all its people.
Author: Rory Ord, Head of Unlisted Investments at 27four Investment Managers
First published in the Business Day: https://www.businesslive.co.za/bd/opinion/2019-02-15-dwindling-state-finances-puts-prescribed-assets-back-on-the-ancs-radar/