FOUNDATION www.atleha-edu.org Atleha-edu Speaking life into investment decisions VOL.13 FROM WALL STREET TO MAIN STREET ALTERNATIVE ASSETS AND YOUR INVESTMENTS REGULATION 28 Impact of new prudential limits INFRASTRUCTURE INVESTMENT Retirement funds’ role in SA’s economy PRIVATE EQUITY What are the opportunities? This educational publication is funded by Fairtree Asset Management and supported by the ASISA Foundation ALSO IN THIS ISSUE: RECAP OF ALTERNATIVE ASSETS | UNDERSTANDING OFFSHORE INVESTMENT REGISTER FOR CPD CREDITS
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educational email on a Friday at 11h00. SIGN UP FOUNDATION INFRASTRUCTURE EXPOSURE through multiple asset classes LONG-TERM INVESTING PRESCRIBED ASSETS AN INTRODUCTION TO TYPES OF INFRASTRUCTURE INVESTMENTS INFRASTRUCTURE RESOURCES FOR RETIREMENT FUNDS VOL.7 www.atleha-edu.org Atleha-edu Speaking life into investment decisions INFRASTRUCTURE INVESTMENTS FOUNDATION RETIREMENT FUNDS ALSO IN
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Please email info@atleha-edu.org or call 021 851 0091 for more information. 02 Regulation 28: What has changed? 04 Commodities: The assets the world utilises Offshoredailyinvestment: Key considerations for retirement funds0608 Infographic: Regulation 28: New prudential limits 1311 Why private equity presents exciting opportunities 06CONTENTS Encouraging infrastructure investment 01 About this Encouragingpublicationinfrastructure investment 16 Test your learning for CPD Credits 13 Offshore investment: Key considerations for retirement funds 02 Regulation 28: What has changed? www.atleha-edu.org Atleha-edu Speaking life into investment decisions
• Spot price: The spot price is the current market price of a security, currency, or commodity available to be bought/sold for immediate settlement. In other words, it is the price at which the sellers and buyers value an asset right now.
ABOUT THIS PUBLICATION
ThiseducationalpublicationisfundedbytheASISAFoundationandPrescient
• Collective Investment Scheme (CIS): A scheme where funds from various investors are pooled together for investment purposes, with each investor entitled to a proportional share of the net benefits of ownership of the underlying assets. The governing statute is the Collective Investment Schemes Control Act 2002 (CISCA).
• Execution risk: The risk that a project or businesses plans are not successful when put into action.
INFRASTUCTUREINVESTMENT
• Future: An exchange-traded contract for delivery of a standard quantity of a specific underlying asset (such as a soft commodity) at a predetermined price and date in the future.
ALTERNATIVE ASSET CLASSES: UNDERSTANDING HEDGE FUNDS
This publication, funded by Fairtree Asset Management and supported by the ASISA Foundation, takes an in-depth look at the implications of these changes and how they widen the scope for retirement fund investment into alternative asset classes.
FOUNDATION
• Shorting: In short selling, an investor borrows stock shares that they believe will drop in price, sells those borrowed shares at market price, then buys back the shares at a lower price. To complete the short sale, the investor returns the shares to the original lender and profits the difference between the buy and sell prices.
decisions
• Option: A contract that gives the holder the right, but not the obligation, to buy or sell an underlying instrument at an agreed price.
FUNDS VOL.7 www.atleha-edu.org Atleha-eduSpeakinglifeintoinvestmentdecisions INFRASTRUCTUREINVESTMENTS www.atleha-edu.org Atleha-edu Speaking life into
GLOSSARY
THISISSUE:
• Impact investments are investments made to generate positive, measurable social and environmental impact alongside a financial return. The wider definition also includes private sector infrastructure projects and therefore allows for a larger number of projects that retirement funds can consider for investment.
In July 2022, National Treasury gazetted the amendments to Regulation 28 of the Pension Funds Act.
• Angel investors are individuals who offer promising start-up companies funding in exchange for a share of the business, usually in the form of equity or royalties. Angel investors may or may not be accredited investors, a classification given only to investors with very high incomes or net worth.
You can also visit our website to read more about alternative asset classes and infrastructure investment, as covered in the following educational publications:
• Correlation is a statistical measure that expresses the extent to which two variables are linearly related (meaning they change together at a constant rate).
INVESTMENTS INFRASTRUCTURE
TYPES
An introduction to infrastructure investments
ALSO EXAMPLESOF UNDERSTANDINGTHEDIFFERENT INFRASTRUCTURE RESOURCESFORRETIREMENT investment
• Intrinsic value is a measure of what an asset is worth. This measure is arrived at by means of an objective calculation or complex financial model, rather than using the currently trading market price of that asset.
PRESCRIBEDASSETS inSouthAfrica ANINTRODUCTIONTO
• Greenfield projects: Investment into new infrastructure, such as new development and construction projects.
• Bootstrapping refers to the process of starting a company with only personal savings, including borrowed or invested funds from family or friends, as well as income from initial sales.
funds 1
Alternative asset classes: Understanding hedge
• Liquidity risk: The risk that assets will generate enough cash flow to service debt payments and any other obligation. Also, the risk associated with pricing assets where market prices are not observable.
Throughout the publication, you will note certain words and terms are highlighted. The glossary on this page provides the definitions for these words and terms, which you can refer to as you work through the publication.
INFRASTRUCTUREEXPOSURE throughmultipleassetclasses LONG-TERMINVESTING andinfrastructure
• Spot market: The market where financial instruments and tangible commodities are traded for immediate settlement, and where there is an actual physical exchange of the underlying instrument or commodity.
• Mean reversion is a financial term for the assumption that an asset's price will tend to converge to the average price over time.
• Long: Going long on a stock or bond is the more conventional investing practice in the capital markets, especially for retail investors. With a long-position investment, the investor purchases an asset and owns it with the expectation that the price is going to rise.
• Market-neutral strategy: With many investment strategies, the whims of the market can drive returns, rather than the investor’s decisions. A market-neutral investment strategy aims to avoid these broader market forces and instead provide returns that do not correlate with the overall market. By taking an approximately equal position in long investments (hoping the price goes up) and short investments (hoping the price goes down), a market-neutral investor hedges against market swings in either direction.
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This educational publication funded by Fairtree Asset Management and supported by the ASISA Foundation VOL.8
• Venture capitalist: a person or company that invests in a business venture, providing capital for a start-up or expansion.
• Look-through principle provides that a fund cannot use an asset structure to circumvent the limits [of Regulation 28], if an asset comprises less than 5% of the aggregate fair value of the assets of the fund, then the fund need only disclose the categories of underlying assets making up the investment, and not each underlying asset.
A limit of 25% has been imposed across all asset classes to limit exposure of retirement funds to any one entity (company), not just infrastructure. However, one exception to the per entity limit is debt instruments issued by, and loans to, the government and any debt or loan guaranteed by the government.
Increased allocation to private equity
Amended Regulation 28 gazetted 1 July 2022, effective 3 January 2023 National Treasury on 1 July 2022 published the final amendments to Regulation 28 of the Pension Funds Act, as published in Notice No. 2230 in Government Gazette No. 46649 of 1 July 2022. The amendments take effect on 3 January 2023 to enable regulators, retirement funds and fund managers to comply with the new regulations. The amendments to Regulation 28 have been positioned by National Treasury to encourage infrastructure investment by retirement funds. The amendments follow two public comment periods on the proposed Regulation 28 changes during 2021. The aim of the amendment is to explicitly enable and reference longer-term infrastructure investment by retirement funds, by increasing maximum limits that funds may invest in. To this extent, the amendments introduce a definition of infrastructure, and sets a limit of 45% for investment in infrastructure investments.
Infrastructure defined in amended Regulation 28 Regulation 28 introduces a definition for investing in infrastructure, specifically “any asset that has or operates with a primary objective of developing, constructing and/or maintaining physical assets and technology structures and systems for the provision of utilities, services or facilities for the economy, businesses, or the public.”
To further facilitate the investment in infrastructure and economic development, the limit between hedge funds and private equity has been split in the amended Regulation 28. There is now a separate and higher allocation to private equity assets, which has been increased by 5% to 15%.
Regulation 28 also requires reporting by retirement funds on their top 20 infrastructure investments.
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REGULATION 28: WHAT HAS CHANGED?
Limit of 25% to all asset classes
This introductory article provides an overview of the amendments to Regulation 28 of the Pension Funds Act, which will take effect in January 2023. overview Regulation 28 of the Pension Funds Act Regulation 28, issued in terms of section 36(1)(bB) of the Pension Funds Act, protects retirement fund member savings by limiting the extent to which funds may invest in a particular asset or in particular asset classes, and prevents excessive concentration risk. This regulation (also referred to as prudential investment guidelines) stipulates the maximum exposure that a fund can have to each type of investment asset class.
Regulation 28 and increased foreign portfolio (offshore) limits
The asset allocation to housing loans granted to retirement fund members has been reduced by 30%, from 95% to 65%, in respect of new housing loans only. This is intended by National Treasury to curb the potential for abuse of the housing loan scheme offered by some retirement funds. The National Treasury in its communication on this housing loan change stated that it is mindful of the important role played by home ownership in wealth creation and in retirement and will continuously monitor this area of investment offered to fund members.
REG.28 LIMIT
and hedge
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IN PRIVATE EQUITY Collective
REG.28
NEW 3
Housing loans
Hedge fund limit of 10% remains, only CISCA-approved hedge funds permitted As part of National Treasury’s approach to aligning various regulatory approaches and achieving consistency, amended Regulation 28 only permits investments in Collective Investment Schemes Control Act 45 of 2002 (CISCA)-approved hedge funds. Similarly, the reporting exclusion on look-through of Collective Investment Scheme (CIS) and insurance policies has been removed to enable the regulators to collect important statistics on underlying exposures, as part of understanding and monitoring linkages in the financial system and for proactive supervision.
Private
PREVIOUS LIMIT VS NEW FOR INVESTING limit of private equity funds equity limit = 10% Private equity limit = 15% (INCREASED - with limit of 10% per fund of private equity funds, and a limit of 5% per private equity fund.)
LOOK-THROUGH PRINCIPLES
“The look-through principle in this context could be explained as the requirement to assess and include for reporting purposes, the composition of underlying investment instruments used in a particular investment structure or investment portfolio. Regulation 28 explains the look-through principle as a rule that states an investor may not circumvent the exposure limits by ignoring the make-up of an underlying asset and must include and disclose the exposure to which the underlying assets relate. With the amendments, the look-through principle now applies to collective investment schemes (CISs) and insurance policies, for example, in all circumstances, even if an audit certificate was issued. This addition will strengthen the understanding of the authorities around underlying exposure to enable proactive supervision.”
Retirement funds continue to be prohibited from investing in crypto assets. The excessive volatility and unregulated nature of crypto assets require a prudent approach, as recent market volatility in such assets demonstrates. Crypto assets defined in amended Regulation 28 Regulation 28 introduces a definition for crypto assets, specifically “means a digital representation of value that is not issued by a central bank, but is capable of being traded, transferred or stored electronically by natural and legal persons for the purpose of payment, investment and other forms of utility; applies cryptographic techniques and uses distributed ledger technology.”
PREVIOUS
Boards of trustees and Regulation 28
While the amended Regulation 28 widens the scope of potential investments for retirement funds, it is important to note that Regulation 28 and its prudential guidelines continue to leave the final decision on any investment to the trustees of each fund, who determine the investment policy for any fund.
ALTERNATIVE ASSETS AND INVESTMENTS Atleha-edu Speaking life into investment decisions To learn more about this topic, please visit our website www.atleha-edu.org or email us at info@atleha-edu.org to find out more about our educational publications, resources and workshops. LEARN MORE • Understanding South African Financial Markets, Sixth Edition. (2019) Van Wyk, K., Botha, Z., Goodspeed, I. • National Treasury Draft Amendments to Regulation 28. Available online: https://tinyurl.com/2ty8x6ak • National Treasury, Gazetted Amendments to Regulation 28. Available online: https://tinyurl.com/3fvv8hxy • FSCA Communication 8 of 2022, • Available online: https://tinyurl.com/25kdczwb
SOURCE: Glacier by Sanlam Available online: https://tinyurl.com/yw93jmyx
On 23 February 2022, following the 2022 Budget announcement by the Minister of Finance, the South African Reserve Bank (SARB) issued Exchange Control Circular No. 10/2022, indicating that the foreign investment limits have been revised upward. Regulation28(3)(i) states that the aggregate exposure to foreign assets must not exceed the maximum allowable amount that a fund may invest in foreign assets as determined by the SARB, or such other amount as may be prescribed. Based on the SARB’s Exchange Control Circular No.10/2022, retirement funds may therefore now acquire foreign exposure up to the revised single limit of 45% in respect of foreign portfolio – or offshore – investments.
Crypto assets
AMENDMENTS TO
HEDGE FUNDS & REGULATION 28 | NEW
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Investment in infrastructure was permitted under Regulation 28 but it did not define or measure “infrastructure” as a specific category. There was NO SPECIFIC ALLOCATION to investments in infrastructure projects. Atleha Speaking life into investment decisions www.atleha-edu.org
PREVIOUS PRUDENTIAL LIMITS UNDER REGULATION INFRASTRUCTURE
In July 2022, National Treasury announced the finalisation of amendments on 3 January 2023. The amendments will widen the scope of potential investment investment limits in certain asset classes. This infographic limit = 10% Hedge funds limit Private Single asset class with a collective limit = (UNCHANGED)10% Hedge funds
The amendment introduces a definition of infrastructure to enable better measurement of a retirement fund’s exposure to infrastructure assets: “Any asset class that entails physical assets constructed for the provision of social* and economic utilities or benefit for the public”. Retirement funds can now invest up to 45% of assets in South African infrastructure projects.
Hedge funds, private equity Asset class group delinked and overall REGULATION 28 INFRASTRUCTURE HEDGE FUNDS & Private equity (INCREASED – with limit of 10% funds, and a limit of 5% * The “social” aspect of the de nition is intended to accommodate impact investing by retirement funds. Impact investments are investments made to generate positive, measurable social and environmental impact alongside a nancial return. The wider de nition also includes private sector infrastructure projects and therefore allows for a larger number of projects that retirement funds can consider for investment.
Retirement funds will continue to be prohibited from investing in crypto assets. “The excessive volatility and unregulated nature of crypto assets require a prudent approach, as recent market volatility in such assets demonstrates,” Treasury said. Pension Act. These changes will take effect funds by, among other things, increasing the of the key changes to Regulation 28. INVESTMENT
References: online: https://tinyurl.com/nhbwjd4r https://tinyurl.com/3kyrzv6c https://tinyurl.com/25kdczwb https://tinyurl.com/mr3jc56z https://tinyurl.com/v2dtw5ma
FSCA available online:
Funds
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Cliffe Dekker Hofmeyr. Available
National Treasury. Available online:
infographic provides an overview
= 10% Private equity limit = 2.5% Other assets collective limit of 15% limit = (UNCHANGED)2.5% Other assets equity funds and other assets overall collective limit removed PRIVATE EQUITY equity limit = 15% 10% per fund of private equity per private equity fund) OFFSHORE
investment for retirement
CRYPTO ASSETS
IOL. Available online:
In the February 2022 budget speech, the Minister of Finance announced an increase in the prudential limit for offshore exposure for institutional investors (therefore retirement funds, long-term insurers and collective investment scheme managers). Previously, the limit was 30% globally and an additional 10% exposure limit for investments in other African markets (outside of SA). These limits have been combined into one foreign prudential limit of 45% and the limit applies to all retirement funds, insurance companies and investment funds. It is no longer necessary to distinguish between foreign as opposed to Africa.
REGULATION 28 & PRIVATE EQUITY NEW PRUDENTIAL LIMITS amendments to Regulation 28 of the
ALTERNATIVE ASSETS AND INVESTMENTS
overview
INFRASTRUCTUREENCOURAGING INVESTMENT
The availability of transport, communication, electricity, safe water, and sanitation – and other basic facilities – has a tremendous impact on improving the quality of life and wellbeing for any country. Infrastructure facilities and services are essential for efficient production of goods and services, transport and trade – all of which spur economic growth –which in turn helps in reducing poverty.
Defining infrastructure
The infrastructure investment limit applicable across all asset categories is 45% in respect of domestic (South African) exposure and an additional limit of 10% in respect of the rest of Africa. RSA infrastructure allocation limit 45% Rest of Africa infrastructure allocation limit 10% 6
It is widely recognised that infrastructure provides the structural economic backbone for any economy. As a result, infrastructure investments by retirement funds support all other investments made by a retirement fund, as well as supporting overall economic growth in South Africa. Sound, stable infrastructure is able to provide and support utilities, services or facilities for the economy, business and society.
Regulation 28 facilitates increased allocation to infrastructure
Specifically, infrastructure refers to: “any asset that has or operates with a primary objective of developing, constructing and/or maintaining physical assets and technology structures and systems for the provision of utilities, services or facilities for the economy, businesses, or the public.”
The amended Regulation 28 gazetted by National Treasury on 1 July 2022 introduced an updated definition for infrastructure investing.
One of the biggest changes to Regulation 28 is around infrastructure investment. This article considers the impact of the newly introduced definition of infrastructure, and prudential limits, on retirement fund investment.
Regulation 28 enables a 45% allocation to infrastructure
The social and public aspects of this updated infrastructure definition has accommodated impact investing by retirement funds. “Impact investments are investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.”
Conversely, Eskom’s re-introduction of loadshedding in 2022 has resulted in economy-wide, far-reaching negative impacts on business and society. This has highlighted South Africa’s vulnerable energy sector as currently the most critical infrastructure sub-sector. While this presents a serious risk to South Africa’s economic growth, it also offers an opportunity for investment into renewable power projects by retirement funds.
Infrastructure assets are typically cash flow generating, which results in positive cash flow profile for retirement funds over time.A retirement fund will therefore need to apply sound due diligence on infrastructure investment projects. Over and above this, trustees need to ensure that the fund manager and intermediaries they appoint to access infrastructure investments and projects have the appropriate team and skillsets in place.
LEARN MORE
Percentages and investment limits applied in Regulation 28 are aimed at protecting retirement fund members against the risk of an excessive concentration of assets in any single asset class and/or individual investment and are not prescribed targets to be met. Assets held by retirement funds on behalf of their members are considered valuable in any country, because they tend to be sizeable and available for the long term. This means that they can be used to provide the funding needed to build infrastructure capacity in the country, which in turn grows the economy and creates jobs. Investment into the right types of infrastructure projects by retirement funds can have the potential to deliver stable, inflation-beating returns over the long term that align well with members’ needs.
• Stable returns and diversification: Investment in infrastructure is less tied to economic cycles, which means they can still provide returns in a downturn. The underlying assets in infrastructure investments are also uncorrelated to more traditional asset classes, such as listed equities, which offers portfolio diversification.
Trustees need to therefore consider the new 45% infrastructure limit in the context of each retirement fund’s benefit objectives and accompanying investment strategy to support the fund objectives.Infrastructure investments, by the nature of the projects and asset type, introduce execution risk and liquidity risk.
• Investment horizon: Infrastructure investments are typically long term in nature.
While positive, it is critical to highlight that infrastructure is a highly complex, specialist asset class. The key difference between infrastructure investments and the listed universe of assets is that infrastructure is generally more structured and less liquid compared to publicly traded equities and bonds.
Characteristics of infrastructure investing
• National Treasury Draft Amendments to Regulation 28. Available online: https://tinyurl.com/2ty8x6ak
Infrastructure investments by retirement funds present both opportunity and risk: they offer stable returns, a longterm investment time horizon, a diversification benefit, and introduce assets uncorrelated to other more traditional asset classes in South Africa and globally. Infrastructure assets produce a real return over time, generally producing inflationlinked cash flows, which enables retirement funds to achieve inflation-beating returns so that retirement benefits can keep pace with inflation. (See graphic below.)
• Less liquidity: A large portion of these assets are unlisted which, among other factors, can make them less liquid.
Trustees in the driving seat for infrastructure investing
INVESTMENTS
The opportunity to increasingly allocate to infrastructure investments and projects places an additional duty on retirement fund trustees to pick well-defined infrastructure projects that provide the returns members need on their savings over the long term, without adding excessive levels of risk. Regulation 28 has always placed a duty on retirement fund trustees to educate themselves sufficiently on any investment (including infrastructure) to be able to adequately assess the merits of an investment.
Regulation 28 states that “before making an investment in and while invested in an asset, consider any factor which may materially affect the sustainable long-term performance of the asset, including those of an environmental, social and governance character and those related to infrastructure investment, taking into account the necessary due diligence and risk-adjusted returns, acting in the best interest of the fund and its members and avoiding conflicts of interests.”
• FSCA Communication 8 of 2022. Available online: https://tinyurl.com/25kdczwb
• OECD, Infrastructure Financing Instruments and Incentives. Available online: https://tinyurl.com/mrxwuctn
Particularly, investing in greenfield investments requires fund managers and advisers to retirement funds to be able to not only understand the investment thesis of an infrastructure investment or project, but to also be able to assess the execution risk presented by the investment. This calls for the application of skillsets beyond the traditional financial analysis undertaken when valuing, for example, listed equity and bonds.
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OF INFRASTRUCTURE CHARACTERISTICS
Understanding the liquidity constraints of infrastructure Retirement funds generally build a liquidity profile into the fund’s overall investment portfolio. This enables the retirement fund – considering its own liquidity requirements – to allocate a portion of its investment portfolio to longer-term, less liquid assets, such as infrastructure and private equity investments.
To learn more about this topic, please visit our website www.atleha-edu.org or email us at info@atleha-edu.org to find out more about our educational publications, resources and workshops.
Regulation 28 requires reporting on top 20 infrastructure holdings
Another addition to Regulation 28 is the requirement for retirement funds to report their top 20 infrastructure investments annually. This reporting requirement is a monitoring mechanism for National Treasury and will likely inform any further specific regulatory guidance on infrastructure investing.
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• National Treasury, Gazetted Amendments to Regulation 28. Available online: https://tinyurl.com/3fvv8hxy
The increased allocation by Regulation 28 to infrastructure and private markets requires a combination of financial analysis, as well as industry specific technical skills.
EXCITING OPPORTUNITIES
COMMON PRIVATE EQUITY INVESTMENT STRUCTURE
• Private equity is privately held as opposed to publicly traded.
The amendments to Regulation 28 have delinked this asset class group. The overall limit for private equity funds is now 15% (with a limit of 10% per fund of private equity funds, and a limit of 5% per private equity fund). Hedge funds and other assets remain unchanged at 10% and 2.5%, respectively. The overall or collective limit has been removed.
Characteristics of private equity investments:
National Treasury has indicated that the increase in the limit applicable to private equity is based on a number of studies which document that private equity investments in infrastructure projects (also see p.6-7 of this publication) have a positive impact and help in sharing project risk between the project sponsors, and for the fact that private Private equity is a broad, catch-all category for essentially any equities that are not publicly listed. At its core, private equity represents capital that is invested into companies. This article looks at the investment opportunities in private equity and how this alternative asset class can drive innovation and help bolster industries and, ultimately, economies.
Ownership of the fund The fund’s ownership of the portfolio of investments
WHY PRIVATE EQUITY PRESENTS
overview
• Private equity investments tend to offer higher risk and higher rewards to investors. Private equity investors seek a higher return on their capital when the company prospers as they risk losing most, if not all of their investment if the company fails. Understanding South African Financial Markets
• Private equity investment entails active involvement in identifying the investment, negotiating and structuring the transaction, and monitoring the company once the investment is made. This may often require an investor to serve as a board member of the investee company.
“A direct or indirect equity or debt investment in one or more privately owned, unlisted companies in pursuit of capital growth that exceeds market returns. In addition to financial returns, some private equity funds also aim to demonstrate social and environmental impact, for example, job creation,” as defined in Understanding South African Financial Markets.
Private equity under Regulation 28 of the Pension Funds Act Previously, “hedge funds, private equity funds and other assets” were defined as a single asset class with a collective limit of 15%. Private equity on its own had a limit of 10%; hedge funds of 10%; and other assets at 2.5%.
Private equity firm (General partner) Limited partners (Investors) (retirement funds, insurance companies, high-net-worth individuals, family offices, endowments, foundations, fund-of-funds, etc.) Private equity fund (Limited partnership) InvestmentA InvestmentB InvestmentC Fund/investment management
SOURCE: :
equity investments can be more proactive in supporting the country’s economic recovery plan.
There are different types of private equity investment structures, but the most common is where silent investors (called limited partners) pool funds alongside an active investment manager (called the general partner) for a fixed period (e.g. ten years). During this time, the fund manager invests the pooled funds and actively manages investments to generate targeted returns. Investments are exited towards the end of the fund term, after which the fund is typically closed.
• Private equity investments are not intended to be held indefinitely. Generally, alternative exit strategies are evaluated at the time the initial investment in the company is made. One such strategy would be to list the company on a stock exchange and sell the shares to the public.
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RECAP: What are private equity funds?
Early-stage/venture private equity
Starting a business from scratch is challenging and venture capital certainly has a role to play in South Africa. Not only from a financial standpoint, but by providing entrepreneurs with the right networks and expertise to give them the space to innovate and grow. With South Africa’s high structural unemployment rate, nurturing well-trained, entrepreneurial leaders can lead to new industries and allow businesses to not only compete on a local level, but also a global one.
This is for pre-revenue companies, such as tech and biotech start-ups, as well as companies that have productmarket fit and some revenue but no substantial growth yet. Venture capitalists and angel investors operate in this space. For example, a company that has been bootstrapped and has since raised angel funding marks the start of the private equity cycle. Venture capital funds and private funds can then become involved and start to support these companies from “seed” stage through to their various expansion stages.
Private equity covers a range of different assets (such as real estate and infrastructure, for example) across various stages. This can either be investing in young companies, or start-ups and continuing to invest through their growth, or investing in later-stage businesses that have established themselves and their profit potential, but are looking to raise capital to expand or improve operations. There is also the case where a publicly listed enterprise decides that the public markets aren’t suitable anymore, and they prefer to grow privately by being acquired and run as a private enterprise.
Late-stage private equity
The business can be grown and improved and is usually returned to the public market at a later stage. In doing this, the aim is to build these companies into industry champions.
Expansion private equity
ALTERNATIVE ASSETS AND INVESTMENTS Atleha-edu Speaking life into investment decisions STAGES OF INVESTMENT OPPORTUNITIES
A South African example: Often, when a South African company wants to go offshore and expand into other markets, it doesn't have access to the required capital to achieve this. South African lenders are happy to provide capital for their South African growth market, but don't want to take risk on their offshore growth, as they aren’t familiar with those markets or customers. At the same time, offshore lenders are not willing to fund them because they come from a foreign country, whose market and customers they are not familiar with. By providing these companies with private equity capital, South African businesses are able to expand into new markets and compete on a global scale.
This investment is typically focused on identifying underperforming businesses and taking them private, where their performance can be significantly improved through creating operational excellence or changing their capital structure.
What role does this stage play in the economy?
This typically involves financing established and mature companies in exchange for equity, often a minority stake, to expand into new markets and/or improve operations. In other words, a business that already has some traction and has already proved itself and needs capital to grow, but may not have access to traditional banking facilities. This could be because the company is still quite young, or it is not publicly listed and can’t raise capital through the market. Growth or expansion private equity helps bridge the funding gap.
All these investment stages have a significant role to play in the growth of an economy.
If vibrant ventures are supported – not only financially, but with the right network of experts – it can drive and spark innovation and unleash great potential.
According to The Southern African Venture Capital and Private Equity Association’s (SAVCA’s) 2021 venture capital survey, 74 fund managers invested R1.39 billion into 122 entities through 167 investment rounds in 2020 amid the Covid-19 crisis, up from the R1.23 billion invested in 69 funds in 2019. At the end of 2020, the South African venture capital industry had R6.87 billion invested in 841 active deals, and added that, of those active deals, 53.4% were invested in seed or start-up businesses.
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VENTURE CAPITAL IN SOUTH AFRICA
Food for thought: There’s much debate about what role private equity/outside investors can play in state-owned enterprises, for example. A debate which is very relevant in the South African context – particularly given our current energy crisis. While this is a complex issue, the need to open up the space for private equity has certainly been identified by the amendments to Regulation 28 in order to unleash investment opportunities within the South African economy.
To learn more about this topic, please visit our website www.atleha-edu.org or email us at info@atleha-edu.org to find out more about our educational publications, resources and workshops.
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• Corporate Finance Institute. Available online: https://tinyurl.com/mwv6dxbx
• National Treasury Draft Amendments to Regulation 28. Available online: https://tinyurl.com/25xsrfs6
Wyk,
• Understanding South African Financial Markets, Sixth Edition. (2019) Van K., Botha, Z.,
Investing in private equity
REFERENCES
When faced with these types of market downswings, that may not even be directly correlated to their operations, listed companies that were perhaps looking to expand through raising capital on the public market, may have difficulty achieving this as their equity value has dropped.
Goodspeed, I.
Private equity investors are looking to generate returns that are higher than they would generally achieve in public markets. They're able to do this by having access to interesting businesses and a greater pool of opportunities that are not widely available. This could be either because the operators of a company do not want to be in the public market, or perhaps they are still at early stage. Investors are able to generate strong returns over a longer time period, with significantly less volatility than in a public market. This is due to the nature of private equity investments, which is centred around a sustained, consistent investment behind strong propositions in order to allow them to realise their potential. For example, when investing in a young company with potential, time is required for that company to be allowed to develop to a point where value will be reached –either by listing on a public exchange or being sold. Similarly, if investing in the expansion of a mature company, time is also required if they are expanding into a new market or building a new production facility, for example.
This long-term investor patience isn’t always possible in public markets, where a company’s equity is priced daily and investors are exposed to market swings and volatility of the public market, and are subject to global events, such as the war in Ukraine, as a recent example.
In the private equity market, companies are not subject to the scrutiny of public markets. Of course, this doesn’t mean private companies don’t have a responsibility towards their investors, but given the long-term, steady nature of private equity investment, private companies operate in an environment where patience is the name of the game – and where broader market events do not generally impact on them as much as a publicly listed company. However, the trade-off lies in this long-term nature of the private equity asset class. Although investors can typically expect greater returns and less volatility, private equity investments come with liquidity constraints. Typical private equity commitments are around 10 years, but can range anywhere from 8 to 12 years.
3. Buying shares of exchange-traded funds (ETFs) that specialise in commodities
Commodities are classified as alternative investments and exposure to them provides investors with an inflation hedge and portfolio diversification, as commodities generally have a low correlation with traditional asset classes, such as equities and bonds. Because commodity prices typically rise when inflation is accelerating, they offer protection from the effects of inflation. Few assets benefit from rising inflation, particularly unexpected inflation, but commodities usually do. As the demand for goods and services increases, the price of goods and services rises as does the price of the commodities used to produce those goods and services.
SOUTH AFRICA: Grains
HARD COMMODITIES SOFT COMMODITIES
There are typically four ways to invest in commodities:
Commodities can be classified into two groups:
1. Investing directly in the commodity (spot market)
A commodity is generally defined as a tangible, unprocessed good with intrinsic value that can be processed further and traded. Given the importance of commodities in daily life, commodity trading began long before modern financial markets evolved as ancient empires developed trade routes for exchanging their goods. Today, commodity markets are highly sophisticated. While hard commodities, such as metals and minerals, are generally well-known, what are the opportunities offered by investing in soft commodities?
COMMODITIES: THE ASSETS THE WORLD UTILISES DAILY
4. Buying shares of stock in companies that produce commodities
Investing in commodities
overview
SOURCE: Fairtree Asset Management
Non-perishable, nonrenewable products that are extracted from mining activities. Examples of these commodities include gold, iron, copper, coal and oil. Renewable (and often perishable) plant or animal resources that can be grown, such as maize, wheat, tea, beef and wool.
Commodity trading is the exchange of different assets, typically futures contracts, that are based on the price of an underlying physical commodity. With the buying or selling of these futures contracts, investors make bets on the expected future value of a given commodity. If they think the price of a commodity will go up, they buy certain futures—or go long—and if they think the price of the commodity will fall, they would sell the futures — or go short.
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Soft commodity investment universe
Soybeans
Investors can invest in commodities through futures and options on regulated exchanges, with some examples being:
Sunflower Wheat White maize YellowMaize INTERNATIONAL Grains (e.g.,wheat)corn, Oilseeds sunflower)soybeans,(e.g., Softs (e.g.,coffee)sugar, Agri-linkedenergy (e.g.,biodiesel)ethanol, Meats (e.g., live cattle and hogs) What makes soft commodities appealing? No matter the state of the world economy, the basic need for soft commodities will always be there. Humans need to eat, for example, so there will always be a demand for food. The price will be determined by that need, but not economic growth per se. While a very weak economic environment will affect equities, soft commodity prices are subject to their own supply and demand factors. From that perspective, soft commodities can buffer an investment portfolio from economic cycles. At the same time, when investing in soft commodities, it is worth noting that they are subject to mean reversion.
2. Using commodity futures contracts to invest
• IG. Available online: https://tinyurl.com/anjru3dh
Pre-1995 Agricultural commodities were traded solely by statecontrolled agricultural marketing boards. Consequently, prices were not transparent and prices were not sufficiently determined by market forces.
• A derivative which has agricultural produce (an agricultural commodity) as the underlying asset.
1995 Deregulation led to the disbanding of the agricultural boards and the start of a proper commodities trading platform in South Africa. This was accomplished with the establishment of the Agricultural Markets Division of the South African Futures Exchange (Safex). The first two futures contracts listed were a beef and a potato contract, both of which did not survive.
• Corporate Finance Institute. Available online: https://tinyurl.com/4try9w67
Mean reversion is a financial theory which suggests that, after an extreme price move, asset prices tend to return back to normal or average levels. So, while soft commodities can be subject to large price swings, these prices will “settle.” From an investor perspective, the risk associated with soft commodities is viewed through a market-neutral lens. In other words, investment returns can be made both when a soft commodity's price goes up or down. Soft commodities can be a powerful portfolio diversifier, but investing in them requires specialised knowledge. A fund manager should not only have financial expertise, but needs a practical understanding of the soft commodities markets, their commercial use and interchangeable characteristics. Commodity-focused hedge funds invest largely, but not exclusively, in financial products that have commodity equities and commodity derivatives as underlying assets. So, investors are not buying the physical asset – but a representative of it. An example being an agricultural derivative. (See box.)
SOURCE: : IAS Parliament
• For example, the value of a futures contract on wheat is based mainly on expected future spot prices of wheat and the storage costs of holding this commodity.
1996 White and yellow maize contracts were listed and became immediately successful. Thus, an era dawned on the maize market in which local producers were provided with the necessary market tools for facilitating effective price discovery and price risk management due to the transparent prices generated in the futures market.
Commodity trading in SA
IAS AvailableParliament.online: https://tinyurl.com/mrxj5w59
• Unlike financial assets, agricultural commodities are valued based on their future expected spot prices rather than future expected cash flows.
• Successful Farming. Export problems plague Ukranian Farmers. Available online: https://tinyurl.com/2jkuw87m
Risks Due to the nature of soft commodities prices being subject to supply and demand forces, the market can be volatile. Soft commodities prices are subject to seasonality and weather conditions. Furthermore, geopolitical risk can also have a significant impact on the supply and demand of soft commodities – as can be seen with war in Ukraine, which has caused a lack of grain exports. Before the start of the war, Ukraine was steadily increasing its production and export of grain. In 2021, Ukraine produced 107 million tonnes of grain, of which it planned to export 70 million tonnes. Prior to the Russian invasion, Ukraine exported 43 million tonnes of grain and oilseed. Another 4 million tonnes were loaded onto ships, but not taken out. Thus, at the beginning of the war, 27 million tonnes of grain were ‘stuck’ in Ukraine.”
REFERENCES
SOURCE: Successful Farming Climate change
The supply of most agricultural products is very sensitive to weather conditions in production areas, especially during the crucial phases in the development of the harvest. Holdover stock of previous seasons could have a significant effect on new-season prices too. The production of livestock and meat products depends much on weather conditions, the price of feed inputs and consumer preferences. Given the current climate crisis, it is likely that the soft commodity market will be more volatile in the future. Seasons have become more unpredictable, which will certainly have an effect on soft commodity production cycles. While this unpredictability can catch the market off guard, in the scenario where the market does become more volatile, fund managers will be able to adjust investment exposures in order to mitigate this.Food scarcity is also a concern – as has been evidenced in the supply chain issues due to the situation in Ukraine, for example. While this is a concern, the market will quickly highlight this and flag the future shortage of, for example, wheat. This will incentivise farmers to start planting crops aggressively to address this market shortfall.
SOURCE: Understanding South African Markets
LEARN MORE
• The Balance. What is a market-neutral investment strategy? Available online: https://tinyurl.com/3eyffuu2
What are agricultural derivatives?
12
1997 A wheat contract was introduced. 1999 A sunflower seed contract was introduced. 2001 Safex was taken over by the JSE.
To learn more about this topic, please visit our website www.atleha-edu.org or email us at info@atleha-edu.org to find out more about our educational publications, resources and workshops.
As the government increased the limits of offshore allocations over the years and relaxed foreign exchange controls – allowing South Africans to shift more money offshore – several unit trust funds investing abroad have been developed. According to the Association for Savings and Investment SA (ASISA), a voluntary industry organisation consisting of fund managers and life insurers, there were 609 foreign collective investment schemes (unit trusts) in SA at the end of March 2022. There were an additional 433 domestic funds that had mandates to investForeignoffshore.collective investment schemes are denominated in foreign currencies, such as the pound, dollar, euro or Australian dollar. They need to be registered with the Financial Sector Conduct Authority (FSCA) before they can market their funds in SA. In order to invest in these foreign unit trusts, retail (individual) investors will need clearance from the Reserve Bank. The Reserve Bank allows an
As the rand weakens, due to the inflation differential with major trading partners (SA historically has a higher inflation rate than developed markets for instance), almost half (45%) of a retirement portfolio is “hedged” and will increase in value.
In terms of Regulation 28 of the Pension Funds Act, retirement funds are now allowed to invest up to 45% of their underlying capital in offshore assets. This article considers the implications and opportunities of this new increased offshore limit. overview
Why is this important? A greater allocation to offshore assets allows a retirement fund the critical opportunity to diversify risk. With more than 40 000 listed companies in the rest of the world, South African retirement funds now have increased access to share sectors that aren’t available locally. This opens up the investment universe to shares such as, for example, Swedish Saab, Danish wind-energy manufacturer Vestas and the world’s only uranium exchange-traded fund (ETF) in Canada, among others.
Offshore investment under Regulation 28 of the Pension Funds Act On 23 February 2022, retirement funds – together with prudential funds – got a reprieve from National Treasury to increase the maximum allocation of funds to offshore assets.
How are offshore funds structured?
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OFFSHORE INVESTMENT: KEY CONSIDERATIONS FOR RETIREMENT FUNDS
In terms of Regulation 28 of the Pension Funds Act, retirement funds are now allowed to invest up to 45% of their underlying capital in offshore assets. Previously, they were allowed to invest a maximum of 30% of their capital in offshore markets with an additional 10% allocated to assets in the rest of Africa. Following the February amendments to Regulation 28, there is currently no difference between investing in the rest of Africa and offshore. In practice, retirement fund investment committees can now allocate significantly more to offshore assets.
Another important consideration is the rand-hedge effect that a greater offshore allocation allows for retirement funds.
To circumvent the onerous foreign exchange controls and processes, local investors can invest an unlimited amount of money in local offshore unit trusts. These unit trusts are denominated in rand and invest their underlying capital in foreign markets. All of these unit trusts need to register in terms of the Collective Investment Schemes Act (CISCA) and are regulated by the FSCA. Most of South Africa’s fund houses, who manage unit trusts, have one or more foreign funds with wide and flexible mandates to invest in foreign assets.Itis necessary to mention that foreign unit trusts and local unit trusts that invest offshore enjoy the same safeguards as those unit trusts that invest domestically. A unit trust is overseen by a board of trustees, whereas the investment decisions are made by an investment management company. The underlying assets never vest in the investment management company and remain the property of unitholders of the unit trust. The unit trust’s financial statements should be audited annually. What types of offshore assets are available?
International obligations: In a rapidly shrinking world with many retirees opting to spend their last years in foreign countries, a sizeable offshore allocation makes sense. It will act as a hedge against rand depreciation, ensuring that a large portion of retirees’ retirement capital remains denominated in a foreign currency.
To learn more about this topic, please visit our website www.atleha-edu.org or email us at info@atleha-edu.org to find out more about our educational publications, resources and workshops.
• Active investing refers to a retirement fund investing in unit trusts or hedge funds with a mandate to invest in foreign assets. Fund managers have dedicated analysts scanning the world’s stock markets for opportunities to invest in different companies, bonds or commodities. These unit trusts or hedge funds are actively managed by investment professionals. Where a retirement fund will need to adhere to foreign-exchange regulations when investing in foreign unit trusts, locally-managed offshore unit trusts don’t attract the same regulatory compliance, except for the 45% maximum allocation limit.
“A greater allocation to offshore assets allows a retirement fund the critical opportunity to diversify risk."
What are the benefits of investing offshore?
The broad classification of assets is the same for offshore and domestic assets. These include shares, property stocks, bonds, money-market instruments, hedge funds and derivatives. Options to invest offshore
There are various benefits to investing a portion of your retirement funds offshore:
Capital stability: Diversifying investments across markets and different currencies reduces the impact of currency depreciation or political events specific to a single market.
• Direct investing entails a retirement fund buying specific assets, such as stocks or bonds, directly on a foreign exchange. The fund will need to open a trading account with a reputable broker, usually large commercial banks in the foreign country, and ensure that it complies with the Reserve Bank’s foreign exchange regulations. This is a risky approach, as a retirement fund’s investment committee may be inexperienced and not necessarily have access to company research.
• ASISA. Available online: https://tinyurl.com/mr3r2fbn • South African Reserve Bank. Available online: https://tinyurl.com/mueuv8vz • National AvailableTreasury.online:https://tinyurl.com/255r3f4b REFERENCES
Various investment options exist for retirement funds opting to invest offshore. Broadly, these can be placed in three categories.
• Passive investing entails a retirement fund buying exchange-traded funds or exchange-traded notes on a foreign exchange. There is a multitude of these products that are linked to an index – which tracks a certain theme –compiled by a reputable indexation company. In this instance, the retirement fund will also need to open a trading account in the country hosting the exchange where the exchangetraded products are listed. It will also need to comply with the Reserve Bank’s foreign exchange regulations.
Choice: South Africa is a concentrated market with only about 330 listed shares and a comparatively small corporate bond market. Most locally listed bonds are issued by financial institutions and attract relatively low yields due to their high quality. Expanding an investment landscape makes it possible for a fund to invest in industries, debt classes, commodities and specialised property stocks which are not necessarily available locally.
individual to invest a maximum of R10 million per calendar year (R11 million if you include the R1 million single discretionary allowance) outside the Common Monetary Area (which includes South Africa, Namibia, Lesotho and eSwatini). Before the money can be moved offshore, the individual will need to prove that his/her tax affairs are in order with SARS.
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Diversification: Exposure to a single currency or country increases a portfolio’s aggregate risk. Diversifying the portfolio’s exposure may enhance returns and reduce the risk associated with a single market.
1. INTRODUCTION TO PRIVATE EQUITY (WHAT IS PRIVATE EQUITY?)
CLICK HERE TO ENROL | CLICK HERE TO VIEW THE BROCHURE
FEEDBACK FROM PAST DELEGATES
RETIREMENT FUND EDUCATION WORKSHOPS
TRUSTEE
1. THE NATURE OF INFRASTRUCTURE INVESTMENTS
THE WORKSHOP’S 3 LEARNING AREAS INCLUDE
3. HOW ARE INFRASTRUCTURE INVESTMENTS FUNDED?
This 3-hour online workshop gives retirement fund trustees and principal officers an introduction to private equity (PE). Topics include PE as an asset class in South Africa, PE investment value chain, PE fees, PE performance relative to other asset classes, its role in responsible investing, risks and mitigating factors and asset allocation limits.
3. OPPORTUNITIES AND CONSIDERATIONS WHEN INCLUDING PRIVATE EQUITY INTO YOUR INVESTMENT PORTFOLIO
2. THE BUSINESS CASE FOR PRIVATE EQUITY (WHY INVEST IN PRIVATE EQUITY?)
INFRASTRUCTURE INVESTING WORKSHOP
4. RISK AND RETURN
“Overall, it was definitely encouraging, and I learnt new things once again. The course would be a great tool for all our staff members.”
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“The program has broadened my perspective in terms of the actual industry, I am learning so much. It has been a great experience so far.”
5. HOW TO INCLUDE INFRASTRUCTURE IN YOUR FUND’S INVESTMENT POLICY STATEMENT (IPS) Accredited CPD provider for the Batseta Council for FundsRetirement PRIVATE EQUITY WORKSHOP
THE WORKSHOP’S 5 LEARNING AREAS INCLUDE
2. THE INVESTMENT CASE FOR THE COUNTRY AND FOR RETIREMENT FUNDS
This 3-hour online workshop gives retirement fund trustees and principal officers an overview of the fundamentals of infrastructure investing and how the principles can be practically applied in retirement funds.
Example question: Please choose the correct answer. TEST YOUR LEARNING TO RECEIVE CPD CREDITS Atleha-edu Consumer Financial Education initiatives are accredited for Continuous Professional Development (CPD) in partnership with the Batseta Council of Retirement Funds for South Africa. To register your CPD credits for having read this Atleha-edu Consumer Education publication, please complete the following quiz and return this completed form via email to: info@atleha-edu.org or post it to: Atleha-edu, Postnet Suite 272, Private Bag, Somerset West, 7129 FalseTrue True or false? Foreign investment limits were revised upward by National Treasury in February 2022. x 1. Fill in the missing words. There are various options for retirement funds to invest offshore. Broadly, these can be placed into three categories: passive investing, active investing and __________ ___________________. 4. Choose the correct answer. Which of the following is not a soft commodity? Yellow maize SoybeansOilCoffee 2. Fill in the missing figure. The overall prudential limit for private equity as per Regulation 28 is __________ 3. True or false? Under Regulation 28, the prudential limit for hedge funds is 2.5%. FalseTrue 5. What does Safex stand for? 6. Fill in the missing words. A common private investment structure typically consists of private investors (called limited partners) who pool funds alongside an active investment manager (called the ___________ __________) for a fixed period. 7. What is CISCA? 8. When do the amendments to Regulation 28 take effect? 9. Fill in the missing word. Regulation 28 defines infrastructure as: “Any asset that has or operates with a primary objective of developing, constructing and/ or maintaining ___________________ assets and technology structures and systems for the provision of utilities, services or facilities for the economy, businesses, or the public.” 10. True or false? Regulation 28 requires retirement funds to report their top 10 infrastructure investments annually. FalseTrue 16
