• Andrew Davison

Prescribed assets – should you be concerned?

Although prescribed assets is not a new concept in South Africa, the ANC’s 2019 election manifestomentioned reintroducing them. Should you be worried, and if so, how much? Andrew Davison, Head of Advice at Old Mutual Corporate Consultants, addresses these questions.

What are prescribed assets?

Prescribed assets are the percentage of retirement funds’ assets (and possibly of other institutional investors) that, by law, have to be allocated to certain government-approved instruments.

The first time they were introduced in South Africa, was in 1956 when the Pension Funds Act was promulgated. Back then, the prescribed assets in question were government bonds.

Over the next two decades, the level of prescription rose until it peaked in 1977 whereafter it tapered off before being scrapped in 1989. For most of this 33-year period, funds had to invest more than half their assets in South African government and parastatal bonds.

At the moment there are other regulations retirement funds have to comply with. For example, Regulation 28 of the Pension Funds Act stipulates that they allocate at least 60% of their assets to South African assets (30% could be invested offshore and a further 10% elsewhere in Africa).

Retirement funds therefore do not have free rein and have to consider certain restrictions when developing their investment strategies.

However, Regulation 28 is very broad and the limits it places on retirement funds aren’t likely to lead to supply-and-demand imbalances with regard to specific assets and still allow for investment strategies that put members’ interests first.

What is important, though, is the specific definition of what exactly is prescribed as is illustrated by these hypothetical examples:

  1. Invest a minimum of 25% in bonds or other debt issued by a South African power utility beginning with the letter E.

  2. Invest a minimum of 10% in any instrument or entity that can be objectively demonstrated to further South Africa’s economic development in the form of low-cost housing, infrastructure development, renewable energy, agricultural development or poverty alleviation.

Clearly, there is a wide chasm between the two, and if Government’s prescriptions were to become too narrow or too specific, as in Example 1, it could be detrimental to retirement funds’ returns.

The principle of using savings to develop the country, both socially and economically, can’t be faulted as long as it is done without jeopardising South Africans’ savings.

That said, the main objection to prescribed assets is that assets usually are prescribed because there isn’t sufficient demand for them based on their investment merits. In other words, if the assets had sufficient investment merits, there would be no need to prescribe them.

Nominating an instrument as a prescribed asset invariably creates an artificial demand for it and if it is narrowly defined and supply is limited, or if supply is controlled, the price of the instrument is likely to rise.

From an investment point of view and all things being equal, a higher price implies lower expected future returns.

At the same time, the prescribed asset will be assured of investment flows, which limits the incentive to deliver competitive returns to investors. If it is an entity like a State-Owned Enterprise (SOE), the incentive to ensure that it is well-run and delivers a decent investment return will also be curtailed.

Putting matters into perspective

It’s important to note that both references to prescribed assets in the ANC’s 2019 manifesto uses the word ‘investigate’. This indicates that the party is still at the initial stage of considering the merits, impact and practical implications of reintroducing prescribed assets.

It should also be noted that this is an ANC election manifesto and hasn’t been made Government policy yet.

The main concern is that the assets most likely to be prescribed are South Africa’s struggling SOEs. Such a narrow definition of prescribed assets would certainly be a concern but isn’t likely. It’s more likely that the prescription will apply to a class of instruments with social and economic development objectives, such as infrastructure or housing. Worrying that precious, limited retirement savings are going to be sunk into Eskom’s debt or used to bail out SAA probably isn’t justified.

The principle of using savings to develop the country, both socially and economically, can’t be faulted as long as it is done without jeopardising South Africans’ savings.

In fact, this wouldn’t be in the interest of Government since they have put tax breaks in place to encourage us to invest in retirement funds. Creating an environment that fosters savings and then scuppering the savings by forcing injudicious investments would be self-defeating.

In this regard, the devil certainly will be in the detail. The definition of prescribed assets and the practical implementation thereof will be crucial to assure South Africa’s savers that their savings will remain secure.

Until we have more clarity, we at Old Mutual Corporate Consultants do not believe that there is any reason to panic. In the event that prescribed assets do materialise at some point in the future, at that stage it will be important to evaluate the specific details of the proposals and then determine the potential impact on retirement planning.