Any mention of a change to Regulation 28 of the Pension Funds Act has the ability to get investors hot under the collar – and not without reason: this is the particular section of the law that determines where asset managers are allowed to invest pension funds.
It is feared that changing even a few words could force pension funds to invest in bankrupt state-owned companies such as South African Airways (SAA) and Eskom.
Or that it could potentially force them to invest a portion of their assets in government bonds, giving government free rein to issue bonds to bail out those same corrupt and bankrupt entities.
However, the spectre of prescribed assets did not appear when National Treasury raised the matter this week, with the proposed changes actually offering fund managers more choice as to where to invest funds, including greater exposure to instruments for financing infrastructure.
Regulation 28 is actually a good piece of legislation.
Treasury reminds people that the regulation, issued in terms of Section 36(1)(bB) of the Pension Funds Act, “reduces excessive and concentration risk to member savings and ensures protection by limiting the extent to which retirement funds may invest in a particular asset or in particular asset classes”.
The regulation limits the exposure of retirement funds to specific asset classes.
Its main purpose is to ensure that individuals do not overexpose their retirement savings to risky asset classes in an effort to protect and promote capital preservation.
Thus, it prevents the trustees of a pension fund from sticking 90% of their members’ life savings into for example a tech listing with a dubious prelisting valuation or into a property syndication flashing glossy brochures and promising excessive returns.
Emphasis on infrastructure
The proposal put out for public comment seeks changes to the categories of different asset types, creating a specific category for investment in infrastructure.
It also sets new limits on asset classes, including specific limits for investments in hedge funds, private equity and infrastructure.
If passed, the new regulations will limit investments in infrastructure projects to a maximum of 45% across all asset classes, with no more than 25% exposure to a single entity.
Currently, hedge funds, private equity and other assets (which includes investments in infrastructure) are defined as a single asset class with a collective investment limit of 15%.
Treasury notes that the review of the regulation follows government’s desire to boost investment in infrastructure to stimulate the economy.
“The current regulation does not define ‘infrastructure’ as a specific category, which is currently spread across a number of asset classes like equity, bonds, loans and private equity,” says an explanatory note issued by Treasury.
“Consequently, current data from retirement funds does not record the exact investment in infrastructure. The proposed amendment therefore introduces a more precise definition of infrastructure to enable much better data and measurement.
“The decision to invest in any asset class, including infrastructure, remains that of the board of trustees of retirement funds.”
The desire to tidy up legislation and open up opportunities to invest in infrastructure is not only pushed by government; removing uncertainty and giving fund managers more leeway has also been requested by the investment industry.
“Pension funds actually like investing in infrastructure,” says Leon Campher, CEO of the Association for Savings and Investment SA (Asisa).
“But not everything,” he adds.
“The industry wants bankable projects with long-term income streams.”
Campher notes that pension fund investment in infrastructure is not that popular in SA, for several specific reasons.
“The first is that there are not many decent projects available to invest in. The only projects that stand out are the renewable energy projects, which attracted R200 billion in investment from different sources. These offered the long-term above-inflation returns that life offices are always looking for.
“We do not want spectacular returns of 20% and 30% – we want stable returns, long-term cash flow and certainty,” says Campher.
Give the investment industry properly prepared projects, with good planning, proper engineering, and proper finance planning, he says – and “the financing will come”.
This process will actually weed out bad projects, as only economically viable projects will attract investment.
“The institution will make the call whether a project is acceptable and viable. Good projects will go ahead and bad ones won’t,” says Campher.
He notes that returns are basically determined by each project; low to start off with and increasing as the project comes on stream and builds up to capacity. “Ideally, the internal rate of return over the longer term will be higher than the return on government bonds.”
A second problem with investing in infrastructure in SA is our pension fund environment, in which provident funds are very popular. “When people resign or change jobs, they can cash out their pension from a provident fund. This means funds need to be fairly liquid and preferring listed investments,” explains Campher. He hints at a solution – listing instruments on a market and promoting trade.
He notes that infrastructure projects are viable as they create economic activity, mentioning that private funders would probably be willing to invest in energy, renewable energy, energy security, desalination, the digital economy, student accommodation, water and sanitation and roads.
However, he cautions that projects will only be successful if SA accepts and promotes the user-pay principle, which becomes problematic at times.
Industry input heeded
Mike Adsetts, deputy chief investments officer of Momentum Investments, says the way the amendments have been drafted shows that input from industry has been considered and gives insight into how government believes that infrastructure investment opportunities will present themselves.
“The legislation is drafted in an enabling rather than prescriptive form, with the infrastructure investments themselves being accommodated within the existing investment types, aligned with industry views,” says Adsetts.
“The limits that are applied are fairly broad. The broadness of the [new infrastructure] category reflects both government’s desire to crowd in private capital into infrastructure as well as a consequence of how the limitation will be measured.
“What is evident is that there is an expectation that a lot of the investments will be through private equity structures, as well as debt. This also aligns with the public private partnership [PPP] model that government is advocating,” he says.
The main issues
He says the main issues investors will need to “grapple” with are the quality of investment opportunities and the quality of government as a partner (where there is a trust issue that needs to be addressed), as well as the liquidity of infrastructure investments.
“The illiquidity of infrastructure is likely to be the main driver that will result in the actual exposure levels being fairly low and nowhere near to the limits proposed in the new amendment,” says Adsetts.
“Nonetheless, the size of the industry is such that even relatively low exposure to infrastructure investment will open a significant pool of potential capital.”
He comes to an important conclusion: “Momentum is supportive of infrastructure investments that are integrated into a well-constructed and diversified portfolio. We already have infrastructure investments in our portfolios and will increase [these] exposure levels in line with the quality of investments available and taking into account the liquidity requirements of our portfolios and client requirements.”
Listen to Nompu Siziba’s interview with Malusi Ndlovu, director of large enterprises at Old Mutual (or read the transcript here):