NEWS & ANALYSIS

Funding govt and SOEs (IV)

Charles Collocott says there are other investment funds which are possible targets for prescribed investments

Funding government and State-Owned Enterprises (IV) – Funds other than pension funds

20 February 2020

The series deals with the following topics:

Introductory brief.

Pension funds.

Funds regulated by the Registrar of Pension Funds.

The Government Employees Pension Fund and other public sector funds not regulated by the Registrar of Pension Funds (1)

The Government Employees Pension Fund and other public sector funds not regulated by the Registrar of Pension Funds (2)

Funds other than pension funds.

Country comparisons (1).

Country comparisons (2).

Conclusion.

INTRODUCTION

Aside from pensions there are other investment funds which are possible targets for prescribed investments. This brief begins by stating which other kind of funds may be targeted followed by a description of them. It then asks if they can afford to take on prescribed investments and finishes with a short conclusion.

FUNDS OTHER THAN PENSIONS WHICH MAY BE TARGETED

In the ANC’s 2019 election manifesto, under the title Transform and Diversify the Financial Sector, it was stated that the party would:

“Investigate the introduction of prescribed assets on financial institution funds within a regulatory framework for socially productive investments (including housing, infrastructure for social and economic development and township and village economy) and job creation whilst considering the risk profiles of the affected entities”.

In a report released in June 2019 by Gill Raine, Senior Policy Advisor at the Association for Savings and Investment in South Africa (ASISA), she said about the above ANC statement that:

“In this context institutions are likely to include pension funds as well as insurance companies and possibly investments that fall under the Collective Investment Schemes Control Act, 2002.”

As of December 2018, these three institutions collectively held R 6.215 trillion in assets, which was deployed as follows (R trillions):

Unit Trusts*

2.175

Life Offices**

2.816

Retirement Savings

1.224

*Unit Trusts are the relevant investment funds under the Collective Investment Schemes Control Act.

** Insurance companies.

Having already dealt with retirement savings in previous briefs, the focus here will be on unit trusts and life offices.

UNIT TRUSTS

A collective investment scheme (CIS) is defined as:

“[A] type of investment vehicle used by investment managers to pool investors’ money to enable them to access investments which they might not otherwise be able to access in their individual capacities. Through a CIS an investor can also achieve a spread of investments in assets such as shares, bonds, deposits, money market instruments, real estate etc. One of the main characteristics of a CIS is that investors get to share the risks and benefits of their investment in a scheme in proportion to the participatory interests in the scheme.”[1]

There are three kinds. First, there are CISs in securities, commonly known as unit trusts. The CIS Control Act changed the name of unit trusts to collective investment schemes and refers to a participatory interest in a scheme, as opposed to a unit in a unit trust fund. However, investors continue to refer to units and unit trusts.

In a unit trust many investors pool their money into a portfolio which is managed by professional investment managers. These managers invest this pooled money in different assets, including a wide range of local and international listed equities, bonds, property and money market instruments. The total value of the pool of investments is split into equal participatory interests or units. When you invest your money in a CIS portfolio, you buy a portion of the participatory interests in the total portfolio. The assets of a CIS portfolio are held by the trustees, which are the large South African banks.

The other two kinds of CISs are in property and participation mortgage bond schemes, which are consider less likely targets for prescribed assets, so we shall focus on unit trusts.

There are several general kinds of unit trusts, all of which hold varying amount of government and SOE bonds. The type of unit trust which would generally hold the highest percentage of assets in government and SOE bonds are fixed income funds followed by balanced funds.

Fixed-income funds invest mainly in fixed-income securities like bonds and money market instruments. Their objective is to provide investors, such as retirees, with a regular source of income. A balanced unit trust fund has a portfolio comprising of a mix of equities, fixed income securities and cash. Money market funds invest in liquid, low risk money market instruments that are in effect short-term deposits (loans) to banks and other-low risk-financial institutions, and in short-term government securities.

According to data collected by ASISA, in aggregate the portfolios of South Africa’s variable term fixed-income funds at the end of September 2019 had invested 55% of their assets in government debt, and 8% in SOE debt.

The same aggregate data is not available for South Africa’s balanced unit trusts, so instead we will look at a single popular fund as an example. The Investec Asset Management (now Ninety One) Absolute Balanced Fund held 0.45% of its portfolio in South African listed bonds at the end of September 2019 – though we do not know how much of this was government or corporate bonds.[2]

In aggregate the portfolios of South Africa’s money market funds at the end of September 2019 had 2% of the portfolios in government issued paper, and held no SOE paper.

LIFE OFFICES / INSURANCE COMPANIES

The products offered by insurance companies require a premium in exchange for receiving a pay out when an incident occurs or a milestone is triggered. Insurance companies use sophisticated modelling strategies that integrate statistical probabilities of potential outcomes which may require large lump sum pay outs to customers.

The premiums received by the insurers are invested into a portfolio of assets designed to match potential pay outs which are recorded as liabilities. Asset / liability matching seeks to ensure that, first, the institution’s assets are growing at a rate of return which at least matches the liabilities and, second, that liquid assets are available to service the liabilities as and when they become due.

As of 30 June 2019, insurance companies on aggregate held over 51% of their investments in government bonds, and 5.7% of the assets were made up of SOE bonds.[3]

CAN UNIT TRUSTS AND INSURANCE COMPANIES SUPPORT FURTHER INVESTMENT INTO SOE DEBT AND EQUITY?

In the FSCA’s booklet of information on CISs, it lists “spreads risk” and “good returns” as two of the several advantages of investing in unit trusts. If a policy of prescribed assets was introduced, unit trust fund managers would most likely be forced to take onto their investment portfolios more government and SOE debt, and possibly SOE equity too, than they otherwise would have. Then, in order to avoid an overconcentration of these asset classes in their portfolios and to maintain required and targeted asset diversity levels, i.e. risk spreading, they would have to sell non-government and non-SOE debt, as well as non-SOE equity.

Because unit trust fund managers will have to substitute a portion of their preferred holdings for prescribe assets, this will have a detrimental effect on the expected returns for unit trusts, thereby suppressing the “good returns” advantage of these funds.

Prescribed assets would also have a negative effect on the returns of the investment portfolios of the insurance companies for the same reasons. This drop in expected returns combined with limiting the insurer’s freedom to choose investments given their liabilities, will increase the risk of the insurance companies’ assets mismatching the liabilities they are supposed to service.This would be especially true for short-term insurers, because SOE and government debt are both long term investments.

CONCLUSION

The combined assets held by South Africa’s unit trust and insurance companies comes to over 80%, or R4.99 trillion, of the total assets of funds other than pension funds. Such a policy will likely cause investors to withdraw funds from these investment vehicles as they seek more competitive and market related returns. As for insurance companies, the industry will face an increased risk in by asset / liability mismatches and premium increases. 

By Charles Collocott, Policy Researcher, HSF, 20 February 2020

[1] FSCA Collective Investment Schemes Booklet.

[2]https://www.fundsdata.co.za/fdov2/holdings.aspx?c=INAB

[3] ASISA Life Stats January to June 2019.