Risks of taking on R250bn of Eskom’s debt
Although the ideal of a fully functioning Eskom is one to which we all aspire, implementing a version of prescribed assets implemented from the 1950s to 1970s is not the ideal solution and is cause for concern.
Stakeholders have suggested that the Public Investment Corporation (PIC) should have its investors - the most significant of which is the Government Employees Pension Fund (GEPF) - take on R250billion of Eskom’s debt.
To understand the principle of using prescribed assets as a means of getting out of a financial fix, we need to take a step back in time. Who were the winners and the losers in the past? Historical numbers show why we should question the value of a prescribed asset approach.
Equity holders gained, bondholders lost out
In the previous period of prescribed assets, there were significant gains, which, ironically, led to the establishment of state-owed entities such as Eskom and Sasol. However, these gains accrued to the equity holders of these entities: the government of the day. The bondholders received a poor return on investment (ROI) when they were forced, through prescription, to invest in the bonds that funded and founded these institutions.
* 1960s: Inflation averaged 3percent. Although prescribed assets earned positive real (after-inflation) returns, they earned -6.4percent a year less compared with equities over the decade.
* 1970s: Inflation averaged 11.3percent. Prescribed assets earned 7.3percent, while equities returned 24.5percent. Therefore the opportunity cost of investing in prescribed assets compared with equities was -17.2percent a year.
* 1980s: Inflation averaged 14.5percent. The opportunity cost of investing in prescribed assets compared with equities was -6.7percent a year.
Prescription mainly affected defined-benefit (DB) retirement funds over this period. This meant that employers who paid the balance of the cost of these funds suffered the loss of ROI rather than fund members.
If we had to reinstate prescription, which ceased in 1989, the opposite would be true now.
The winners and losers would switch chairs: employees of what are now mainly defined-contribution (DC) funds would take the knock as bondholders. Employers would not be affected by suffering the opportunity cost of prescribed assets.
Equity holders would gain, bondholders would lose
It would still be the equity holders, if any, who would benefit from a “revitalised, revamped, non-corrupt” Eskom. However, the bondholders would suffer from:
* Poorer bond returns since these are not based on purely commercial terms.
* The loss of opportunity to invest in other assets that better meet their risk and return objectives.
This major shift from winners to losers results from the fact that most retirement funds are now DC funds. A change from DB to DC means that it is the members of the funds who will suffer. Simply put, every member of a DC fund that produces poorer returns due to prescription will retire or leave their funds, with less money than they would have in the absence of prescription.
In respect of the GEPF, taxpayers will suffer
There are still several large DB funds in South Africa, specifically the GEPF. In this case, it is the employer who will suffer from the poorer investment returns. However, since the employer in this case is the government, ultimately it is the taxpayers who will suffer through higher contributions, funded from tax revenues, that will have to be paid into the GEPF.
For this reason, we do not support the imposition of prescription that prevents investors from investing in assets that meet their risk and return profiles. If investors are being forced to invest in assets through prescription, the investments will give suboptimal investment outcomes that will not be in the interests of investors:
* Members of DC retirement funds, in particular, who rely on investment returns to build up their retirement savings.
* Pensioners who rely on investment returns to support their pension increases.
We are extremely supportive of efforts to drive the voluntary mobilisation of funds to support developmental objectives. What we would not support is the concept of this investment being forced through prescription because of a risk of a loss of ROI for individuals who rely on the value of their retirement fund as their main form of life savings.
Janina Slawski is head of investments consulting at Alexander Forbes.