The potential unintended consequences of prescribed assets

In the ANC’s 2019 election manifesto, the party noted that it intends to “investigate the introduction of prescribed assets on financial institutions’ funds to mobilise funds within a regulatory framework for socially productive investments”. This would mean requiring pension funds and other large institutions to invest a certain percent of their portfolios in things such as housing, infrastructure and social and economic development.

It is almost impossible to find anyone outside of the ANC who thinks this is a good idea.

South Africa had prescribed assets for many years leading up to the late 1980s, and they were abolished for good reason.

History provides a stark reminder

As Gill Raine, senior policy advisor at the Association for Savings and Investment South Africa (Asisa) told the Actuarial Society’s investment seminar in Cape Town on Thursday, it is possible to examine the cost to investors of the prescribed assets policy in the 1970s and 1980s. The 1970s in particular provide a stark reminder of the impact the policy had.

Over that decade, inflation in South Africa averaged 11.3%, and prescribed bonds delivered a negative real return of 4% per year. Equities returned 13.2% above inflation over the same period. As pension funds were forced to invest at least 53% of their portfolios in government and state-owned company bonds, they had to be exposed to their relative underperformance, even though local equities were enjoying such a strong run.

It is extremely difficult to align this with the responsibilities placed on pension fund trustees under Regulation 28. The regulation insists that trustees have a “fiduciary responsibility” to manage the fund’s assets responsibly and to deploy capital into markets that will “earn adequate risk adjusted returns”. They simply can’t do this with one hand tied behind their backs.

It is primarily for this reason that the general feeling in the industry is that prescribed assets are unlikely to be implemented. The potential impact on ordinary South Africans would simply be too great.

Bond liquidity

However, Raine argues that the likely consequences would go far beyond just the obvious impact on retirement outcomes for savers. There are a number of potential unintended repercussions that also need to be considered.

Firstly, the abolishment of prescribed assets had a significant impact on the local bond market, particularly in terms of liquidity.

It’s impossible to tell how much liquidity would be sucked out again if the country returned to that kind of regime.

“In the era of prescribed assets, bonds were valued at the lower of their cost or redemption value,” says Raine. “Bonds were issued at a huge discount and hardly traded, because investors didn’t want to sell a bond at a loss. If they did, they would just have to buy more to top up on their prescribed requirements.”

Around 38% of all government bonds are now owned by foreigners. If liquidity dried up, that would be a major disincentive for them, and would potentially lead to capital flight. That is not something South Africa can afford.

Asset managers

Raine also notes that the abolition of prescribed assets led to a material change in the structure of the local asset management industry, as it allowed for genuine competition. This is what allowed the rise of independent asset managers.

“Prior to this you didn’t have any peer review comparison and you certainly didn’t have benchmark performance,” she says. “Surveys only emerged once you had independent asset managers.”

One therefore has to question what a return to prescribed assets would mean for an industry that has grown highly competitive and diverse. Would the many boutique managers that are now managing assets be sustainable?

“We don’t know what the unintended consequences would be,” says Raine. “Just as when prescribed assets were abolished we had no idea what it would mean for the dynamics of the asset management industry in South Africa.”

Systemic risk

There is also the problem that implementing prescribed assets would require pension funds and institutional investors to materially change their current asset allocation. According to Asisa, the funds held in vehicles that could potentially be impacted total R10.96 billion.

“Any change in asset allocation has potential systemic risks,” she says. “A sale of equities to move into fixed income would have huge wealth effects across the industry.”

Even a regulation that required these investors to move just 10% out of equities into prescribed assets would mean a figure of R1.1 trillion. That is equivalent to more than 7% of the JSE that would have to be sold.

It’s extremely difficult to see how this would be done in an orderly fashion, without have an obvious impact on stock prices that would be felt not just by these funds themselves, but investors across the JSE.

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