Opportunity cost of forced investing may outweigh developmental needs

The South African government is finding itself between a fiscal Scylla and an economic Charybdis, where state debt is burgeoning, and the economy is stalling. 

In order to try and plug holes in its fiscus, and those of public enterprises such as Eskom, Transnet and a sleuth of others, National Treasury is now turning to South Africans’ retirement money.

Treasury plans to reintroduce a notorious and widely contended asset management policy of prescribed assets which was abandoned in the late 1980s. 

Prescribed assets in SA were first introduced in 1956 through the Pension Funds Act, when retirement funds were required to invest more than half of their assets into government and state-owned enterprises’ (SOE’s) bonds. 

Prescribing where assets should be invested was a way of compelling fund managers to invest in certain sectors or companies. 

The National Party government utilised the retirement funds of domestic savers to fund capital projects of parastatals such as Eskom and the construction of Sasol’s coal-to-liquid plants; and, recently, the ANC has been increasingly likely to go down this route too, as the state continues to spend more than it earns and can afford. 

During the years of prescription, the prudential investment guidelines (PIGs) required that 53% of retirement fund assets, 33% of assets of long-term insurance companies and 75% of the Public Investment Commissioners’ (now Public Investment Corporation or PIC’s) managed assets be invested into government and SOE bonds, says Janina Slawski, principal investment consultant at Alexander Forbes Investments.

The opportunity cost of prescribing assetsGill Raine, senior policy adviser at the Association of Savings and Investment SA (Asisa), says that during the 1960s to 1980s when prescription was in place, there was an opportunity cost to investors holding bonds rather than equities. 

The opportunity cost of investing in prescribed assets rather than equities at the time was consistently negative over the decades in which the policy was enacted.

To date, no detail has been provided by the government or ruling party in terms of the form that the prescription should take, except that it is on the cards and will most likely fund Eskom’s split into separate units for generation, transmission and distribution. 

President Cyril Ramaphosa on 3 March during a meeting with editors and journalists held by the SA National Editors’ Forum said that the money to help reduce the government’s debt obligations, such as Eskom’s more than R450bn load, lies in the country’s retirement funds.

“The Reserve Bank estimates that there is over R8tr in pension funds. Imagine if 10% of that went into alternative investments – that’s R800bn for Eskom and water projects,” Ramaphosa said at the meeting, according to Fin24. 

Parliament’s portfolio committee on public enterprises on 4 March heard from the Congress of SA Trade Unions (Cosatu) that the Development Bank of SA and the PIC, which has R104bn invested in government-guaranteed Eskom bonds, could both increase their exposure to Eskom debt, according to a Fin24 report.

What could possibly go wrong?

The reintroduction of prescribed assets could have a profound effect on ordinary South Africans, inflicting damage that goes far beyond just the obvious impact on retirement outcomes, says Kevin Lings, Stanlib’s chief economist. 

“In general, it would undermine domestic and international investor confidence, encourage foreign capital outflows, discourage discretionary savings, weaken SA’s international credit rating, and undermine the country’s ability to raise foreign finance,” he says.

The reintroduction could lead to a potential reduction in investment returns and would leave pension fund members poorer, contrary to the positive changes achieved to date through the retirement reform initiatives, says Slawski. 

“It [the prescribed assets policy] would be introduced in a period of expected low returns, when it is critical that all focus should be on maximising returns,” she says.

At the beginning of March, Stats SA reported that the SA economy slipped into a recession during the second half of 2019. Real GDP shrank by 1.4% quarter-on-quarter on an annualised basis during the three-month period. 

This resulted in economic growth averaging 0.2% in 2019.On the additional plausible perils of reintroducing prescribed assets, Isaah Mhlanga, executive chief economist at Alexander Forbes, says that prescription is pursued because something is not working, with reference to SOEs. 

“Return on equity for all SOEs has been negative; making use of this tool means that investors risk getting negative returns on their investment,” he says.

Mhlanga says there are four considerations at play when discussing prescribed assets. Firstly, introducing prescribed assets may deter savers and investors further because of the opportunity cost involved.

Secondly, there are already significant challenges in encouraging individuals to save sufficiently for their retirement and to ensure that they preserve their savings on exit.

Thirdly, the introduction of prescription will result in a reduction in member confidence in the retirement system. And finally, a point may be reached where individuals prefer to save outside the retirement system where greater returns can be achieved, even though retirement funds provide better tax incentives.

Trustees of retirement funds have a fiduciary duty to act in the best interests of members and “prescribed assets will limit the extent to which trustees can fulfil these duties”, says Slawski. 

“Prescribed assets would go against the intention of prevailing legislation and the requirements of trustees.”

If enforced, the nature of the investment will be problematic, as investors would not have the opportunity to negotiate better terms for the investment or be able to walk away from unfavourable terms, she says.

The policy will likely leave people with a smaller pension pot when they do retire or having to work for longer than they had planned to, says the Institute of Race Relations' Marius Roodt. 

“A large number of people will be affected,” he says. “Between 11m and 13m South Africans either contribute to or draw from a pension fund.” 

This article originally appeared in the 19 March edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.