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This article first appeared in Personal Finance Magazine 3rd quarter 2017

Accountants refer to asset classes as either non-current assets or current assets. 

There is a distinctly different approach to asset classification from a fund manager’s perspective. Both group assets together to make important distinctions relevant to decision-making. Many other references to assets are made in business jargon. The confusion only gets worse when referring to human capital. 

In accounting terminology, one has capital on the one side and assets on the other side of the equation. (Perhaps it is time to challenge companies to come up with more innovative financial records. The labour unions, and workers in general, would enjoy this exercise.)

One may ask why investment assets are grouped in different classes. The reason can be found in the definition of asset classes. The following explanation is provided by Wikipedia: “An asset class is a group of instruments which have similar financial characteristics and behave similarly in the marketplace. 

We can often break these instruments into those having to do with real assets and those having to do with financial assets. Often, assets within the same asset class are subject to the same laws and regulations; however, this is not always true. For instance, futures on an asset are often considered part of the same asset class as the underlying instrument but are subject to different regulations than the underlying instrument.”

It is true that, in most cases, one can expect a mixed bag from asset-class returns, which reinforces the principle that it is prudent to maintain a well-diversified investment portfolio.

This brings us to the most important legislation that affects almost all employees in South Africa: regulation 28 issued under the Pension Funds Act. The aim of this regulation is to ensure that a prudent approach is followed in the asset spread of an investment portfolio. 

One of the definitions in regulation 28 is that of an institution’s “investment policy statement”, which means a document that “describes a fund’s general investment philosophy and objectives as determined by its liability profile and risk appetite”. Pension and retirement funds in South Africa must at all times comply with the limits as set out in this regulation.

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Retirement funds can invest in the following categories of assets:

1. Cash, which includes:

  • Notes and coins;
  • Any balance or deposit in an account held with a South African bank;
  • A money market instrument issued by a South African bank, including an Islamic liquidity management financial instrument; 
  • Any positive net balance in a margin account with an exchange; and
  • Any positive net balance in a settlement account with an exchange, operated for the buying and selling of assets.

2. Debt instruments (including Islamic debt instruments), which include:

  • Debt instruments issued by or guaranteed by the Republic;
  • Debt instruments issued by a foreign country;
  • Debt instruments issued or guaranteed by a South African Bank against its balance sheet;
  • Debt instruments listed and not listed on an exchange; and
  • Debt instruments issued or guaranteed by an entity that is listed on an exchange. The investment limits are in accordance with the market capitalisation of the listed entity.

3. Equities (South African and foreign), which include preference and ordinary shares in companies, excluding shares in property companies, listed on an exchange. Limits are imposed relative to the market capitalisation of the issuer. There is also a limit on the amount that may be invested of preference shares and ordinary shares not listed on an exchange.

4. Immovable property (South African and foreign), which include preference shares, ordinary shares and linked units comprising shares linked to debentures in property companies, or units in a collective investment scheme in property, listed on an exchange. The limits are in line with the market capitalisation of the company. 

5. Commodities (South African and foreign), which include Krugerrands and other commodities listed on an exchange, including exchange traded commodities. Gold exposure can be more than other commodities.

6. An investment in the business of a participating employer in terms of section 19(4) of the Pension Funds Act.

7. Housing loans granted to members in accordance with provisions of section 19(5) of the Act.

8. Hedge funds, private equity funds. There are limits on funds operating in South Africa and in foreign countries. In addition, exposure per fund is limited. 

9. Other assets not included in this schedule. Retirement funds are limited to an exposure of 2.5%.

Annually, more than R47 billion invested in the industry is tax-deductible. Individuals should make better use of this powerful wealth multiplier. An after-tax investment should earn substantially more than that of a before tax return. If investors can earn 10% on a portfolio managed by a professional fund manager, they would need to earn at least 13% to break even with such a return. 

The fund manager will be bound by regulation 28 of the Pension Funds Act, whereas the individual will find it impossible to adhere to similar self-imposed prudent principles.

The average amount that individuals are contributing for retirement is substantially below what they ought to be setting aside for retirement.

Discretionary fund managers (those not subject to the Pension Funds Act or regulation 28) have a different approach to asset classification. They classify assets into sub-groups that make sense from a managing and monitoring perspective: global cash, global bonds, global property, domestic cash, domestic bonds, domestic property and domestic equities.

Typically, fund managers would sub-divide these asset classes further:

  • Equities: domestic and foreign industrial, domestic and foreign resources, domestic and foreign financials;
  • Bonds: long bonds, medium-term bonds, short-term bonds, government, parastatal (such as Eskom and Transnet) and commercial paper;
  • Cash: local and foreign; and
  • Property, which is invested in sub-groupings whose fundamentals are not driven entirely by the same factors. A distinction is made between retail, industrial and commercial property. Further, a prudent regional spread is sought and concentration risk is avoided. 

For each asset class, there would typically be a strategy pertaining to each sub-group such as:

  • Overweight: a tactical recommendation to hold more of the asset class than specified in the strategic asset allocation. 
  • Neutral: a tactical recommendation to hold the asset class in line with its weight in the strategic asset allocation.
  • Underweight: a tactical recommendation to hold less of the asset class than specified in the strategic asset allocation.

Implications of asset classification for decision-making

According to Statistics SA, there were 4 788 334 taxpayers in South Africa in 2015. This number has been declining for the past five years. It is interesting to note that the number of taxpayers earning less than R250 000 a year has been falling, whereas those earning more than this amount has been rising over the past five years. Overall, there has been a decline in the number of taxpayers, but an increase in tax paid. Is this trend sustainable?

Who is most likely to be interested to know more about asset classes: men or women? The interest in what asset classes are available for investment will obviously be those people earning surplus income that is not necessary for immediate consumption. In a country such as South Africa, with its large disparity between the affluent and the less fortunate, it alarming to look at the income spread of its citizens.

Data from Statistics SA (2015) indicates that 70% of taxes are paid by men, and it would follow that the majority of member’s interest managed by pension funds are managed on behalf of male members. Gender equality obviously has a long way to go. Interest in investment performance and the underlying assets that create and preserve wealth is probably still more closely followed by men than women.

The argument over active versus passive management comes into play when allocating to and reweighting the asset classes. Trading costs are a factor, as much as a shift in fundamentals that may have changed for a particular investment, sector or region.

Spreading investments across asset classes, currencies and political dispensations lowers risk and is a general accepted investment principle among professional fund managers.

Corrie Kruger is Small Business Service Relationship Manager at Nedbank.

- PERSONAL FINANCE ONLINE