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Is Regulation 28 due a major overhaul?

26 October 2020 Gareth Stokes

The ongoing trend of companies delisting from the JSE could force National Treasury to make amendments to Regulation 28, whether they wish to or not. Regulation 28 was introduced under the Pension Funds Act to prevent asset managers from taking excessive risk with South Africa’s retirement savings. The regulation, last amended in 2011, limits the maximum capital allocations that retirement savers can make to various asset classes such as bonds, equities and real estate, with additional sub limits for alternative investments and the percentage of a portfolio that may be held offshore, among others.

Where did all the listed companies go?

Asset managers are concerned that the universe of listable opportunities from which they can ‘fill’ their domestic equity allocation, has contracted massively over the years. A few days ago, on 19 October 2020, African Oxygen (Afrox) became the latest JSE-listed firm to announce it had been bought out by an US/German company and would subsequently delist from both the South African and Namibian bourses. Afrox is one of more than 250 firms to have exited the JSE since the early 2000s. 

Todd Micklethwaite, Head of Strategy & Impact at Sanlam Investments, told attendees at a webinar, held 4 September 2020, that opportunities in private markets substantially outweigh those in listed markets. “The number of listings on the JSE has halved since 1994, while the capital committed to the private equity industry has grown around 10% over the past decade,” he said. His observation explains why there is increasing pressure to lift the regulatory caps on alternative asset classes and allow greater portions of retirement savings to flow to private equity and venture capital opportunities, among other private market asset classes. 

Such a relaxation would have positive implications for the broader economy as it shrugs off the impact of COVID-19. Tanya van Lill, CEO of the Southern African Venture Capital and Private Equity Association (SAVCA), suggested that a relaxation of the regulatory cap for alternative assets could be a game changer for the country’s hard-hit small and medium enterprises (SMEs). 

Saving the economy, creating jobs

In a SAVCA media statement, issued 21 October 2020, the association stated that a simple amendment to Regulation 28 could support the country’s economic recovery by allowing more investment into the SME-focused private equity class. They argue that capital unlocked in this way would be more beneficial to struggling firms than government’s COVID-19 loan scheme because SMEs were keen to de-risk rather than take on more credit. The regulation currently allows for a maximum of 15% of retirement savings to be allocated to alternative investments, with a sub limit of 10% for private equity. SAVCA proposes the following simple changes:

First, that hedge funds and private equity be separated into independent asset classes, each with their own caps. “This would enable investment decision makers to model the asset classes independently in their portfolio construction process, so as to properly accommodate the risk and return characteristics of each,” said Lill. And second, to gradually increase the private equity cap from 10% to 15%, perhaps by 1% each year. “Increasing the private equity cap would allow a pension fund to take a larger exposure to the entire asset class, enabling a higher degree of diversification, and improving the overall financial security of pension fund savers,” she said. 

Driving social outcomes with impact investing

There is also a growing contingent of asset managers who are supportive of changes to Regulation 28 as an alternative to the prescribed asset concept. Dawie de Villiers, CEO at Alexander Forbes, said it made sense to “shift the investment model to one that is driven by investing in attractive opportunities with higher economic and social benefits”. De Villiers was presenting during a ‘Partnering for better financial well-being outcomes’ discussion, held early-August. His views were backed up by Janina Slawski, Head of Investment Consulting at the firm, who offered impact investing as a workable alternative to prescribed assets. Impact investing is designed to give market-related investment returns that have an underlying positive impact on the community and infrastructure into which it invests. 

The challenge with impact investing is that most qualifying investment opportunities are in unlisted and illiquid private markets. “Current limits in Regulation 28 do allow investments into unlisted assets; but not at a huge level because of liquidity concerns in the defined contribution fund environment,” said Slawski. “The discussion is thus focused on whether the regulatory limits should be increased and whether infrastructure should be included as a new asset class in the regulation”. 

Attractive returns from private markets

During a September presentation titled ‘The investment case for private markets’, Micklethwaite observed that there were “a broad range of private market asset classes with inherent characteristics which offered investors the opportunity for attractive returns, on both an absolute and risk-adjusted basis”. He added that the market for unlisted assets was substantial and, that where such assets were incorporated in retirement funds, they had generally proved beneficial. 

Micklethwaite presented a compelling argument for increased exposure to private markets, comparing a diversified Regulation 28 compliant portfolio that contained only listed assets, to one that included a 20% allocation to private markets. “We can demonstrate,  purely based on historical performance, that there is an investment case for considering private markets,” he said. The caveat is to balance the liquidity associated with such investments with fund members’ needs. 

Writer’s thoughts:
The arguments for increasing private markets exposure in the retirement fund space are compelling; but there are risks. One observation is that retirement fund trustees steer way from utilising the existing private equity cap due to concerns over a breach of their fiduciary duties to fund members. We would not, however, be surprised to see an ‘impact investing’ or ‘infrastructure’ category included within the alternative asset class in future. Have you considered the private markets debate? And do you currently invest any of your clients’ discretionary capital into private equity or venture capital opportunities? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].

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