January, 2019 - Ignoring the data is hard. Several studies conducted by industry bodies, audit firms, investment consultants and others showed that in a depressed 2018 market, private equity still outperformed listed equities in all key matrices such as return on investment, growth in assets under management, and the ratio of local jobs created and retained relative to the investment universe. Not only did they outperform the listed market but generally delivered inflation-bearing numbers.

It is without question that the alternative asset industry in South Africa is ideally situated to help realise the economic stimulus plan. Increasing allocations to private equity, venture capital, and private debt funds have a real transformative effect on the local economy. These funds generally back the country’s middle market, stimulating innovation, the job market, and improving health care, housing, education, and infrastructure at a market rate of return.

Regulation 28 of the Pension Funds Act limits an institution’s exposure in alternative assets to 15%, with a maximum of 10% allowable for private equity. The South African pension fund industry has more than R4 trillion AUM, meaning there is circa R400 billion available for investment into alternative assets. Total investment into alternatives in South Africa currently sits at around 1% or less than R40 billion. The balance of institutional allocations is invested primarily in listed equities. The value of listed company contributions to the South African economy is indisputable, but they have a limited transformative impact within the South African context.

To illustrate, listed JSE shares as a regulated asset class may boost short-term profit-taking, but it diminishes the asset owner’s (pension fund) ability to influence the listed investee company’s tangible contribution to South Africa’s economic and social development, and long-term sustainability.

Even though Regulation 28 stipulates a 30% cap on ex-SA exposure (25% international; 5% Africa), the reality is that the actual ex-SA exposure of current pension funds is substantially higher. The reason is that many of the ‘local’ listed companies are more global in nature due to their push for increased geographic diversification, growth, access to technology, and foreign-currency earnings.

Approximately 65% of revenue generated by JSE listed companies comes from abroad. Examples of such companies are Anheuser-Busch InBev, Naspers, Glencore, Sasol, British American Tobacco, MTN, and so on. Lastly, 60% of South Africa’s economic activities and a sizeable portion of the domestic investment, both listed and unlisted, concentrate around the four main cities of Johannesburg, Durban, Pretoria, and Cape Town.

This concentration of investment and risk has increased urban migration at a faster pace than what the system can manage. Many people are coming to the cities looking for opportunity only to find themselves sucked into the social ills perpetuated by high unemployment in the over-burdened centres.

Decentralising domestic investment from the main cities into the secondary towns of South Africa can stimulate the economy to a greater degree than is already the case. There are ample investment opportunities available in these areas which will counter the social burdens experienced in the cities. Consider for a moment, that the membership of the largest South African pension funds spread across South Africa’s nine provinces, but their savings are funnelled into the four main cities as a default because of the high exposure to the highly regulated listed market. In effect, most economic investments made by pension funds that affect quality of life are taking place outside of the areas many of their members will retire to and where their families live.

What Role Can Pension Funds Play?

While most pension funds have or are starting to map their portfolio to the environment, social, and governance (ESG) requirements, they are not yet necessarily connecting it to transformation goals and “proudly South African” objectives. Doing so would require accountability and reporting along the investment chain to include details like, “How many jobs did my investment create?” “How did my investment improve South Africa’s global competitiveness?” “To what extent did my investment provide economic growth outside of the key metropoles?”

What are the opportunities for pension funds to bolster the economy and drive social change while ensuring a return on investment for its members? To start, pension fund owners should see themselves as vital catalysts for change. Secondly, they should actively seek opportunities where they can drive investment allocations into asset classes that have a direct local, social, and economic impact at market rate returns. These alternative asset classes include private equity, unlisted real estate, venture capital, and private debt funds focused on the middle market and SMEs - the main engines of job creation and growth.

Increasing allocations to alternative assets have a real transformative effect on the local economy, but this kind of change requires pension funds to have a louder voice. There are several steps pension funds can follow to achieve this.

• The trustees of the pension funds should consider expanding their investment policy statement to include the requirement for a portion of the pension funds’ assets to be managed by managers who recognise the value of ESG and Transformation and delivering social returns. Doing this will give pension funds an active voice in their investments, channelling their assets into areas that have both local impacts on where their pension members are located and ensuring market-related returns for their members.

• Pension funds can ease this process by creating transparency between the board, the investment committee, the investment consultant, and the investment managers concerning the investment policies and social objectives of the pension fund. These aims could include investments in specific sectors, targeted geographical areas, job creation, and retention.

• Pension funds can also become active participants in fund governance. Unlike listed investments where pension funds generally invest through external fund managers and vote by proxy, investments in private equity, unlisted real estate, and debt give the pension fund an opportunity to participate actively in the governance structures of these funds. Funds nominating an independent investment committee member and, or an advisory board member who has a clear understanding of the pension fund’s investment policy objectives can ensure their fiduciary duties to their members are not compromised.

• Pension funds can formulate the alternative asset fund strategy in conjunction with the fund manager(s). Globally, private equity strategy is driven by a coming together of ideas from Government, pension funds and investment managers. In some instances, pension funds even go as far as to co-develop strategies and help formulate a team to execute the strategy. CalPers in the United States is a fund that has successfully used its influence to achieve the desired social impact without compromising on financial returns.

The saying, “the whole is greater than the sum of its parts” cannot be more relevant to trustees selecting where to invest the assets of the pension fund. As outlined in Regulation 28, each asset class has its place, balancing and safeguarding assets and protecting member objectives. Nonetheless, the whole is not and cannot be complete unless a part of that selection includes investments in alternative asset classes such as private equity, unlisted real estate, venture capital, and private debt funds. By investing in alternative assets, the pension funds complete not only the whole but more importantly, they become catalysts driving both social and economic change within South Africa.