Issue: December 08/February 09
Editorials

PUBLIC INVESTMENT CORPORATION

The plum in the offing

Asset managers are keen to make their skills available for government employees to get the best pensions at least cost to the state, which guarantees the benefits. Their enthusiasm is not entirely altruistic. The PIC is about to make an important call on its first open tender, allowing a host of new participants.

Few prizes are more keenly sought in the asset-management industry than to be appointed an external manager for the Public Investment Corporation. This is not only because of the prestige it carries. It is also because of the money, like maybe R200m in yearly fee income for the active management alone.

There’s no separate disclosure in the latest PIC annual report, to end-March 2008, of the fees earned by external managers. The cumulative amount is difficult to quantify. Chunks of the equity portfolio have been clawed back for in-house passive management, which would reduce the fees’ total from previous years. Then, there are such extraneous costs as brokerage, which must presumably be added to the fees.

The PIC report discloses revenue of R350m from management fees (up from R112m in 2007), but they aren’t broken down into equity and non-equity portions of PIC assets under management. Neither is it apparent whether this R350m includes amounts passed on to external managers. That their fees are performance-based makes it still more difficult to ascertain how much each received in hard cash as opposed to the remuneration formula. (See Q&A with PIC chief investment officer Daniel Matjila.)

Even industry insiders are reluctant to guess at specific figures. Whatever the total, it’s been shared disproportionately (depending on performance of respective asset proportions actively managed) between five private-sector managers. All five have been the PIC’s external asset managers for the past 12 years.

Back in 1996, they represented a cross-section from SA institutions: Futuregrowth (then part of Southern Life, now part of Old Mutual), Old Mutual, Sanlam, Liberty Life (now Stanlib, formed by merger of the Liberty and Standard Bank asset-management operations), and RMB (part of FirstRand).

Things are about to change radically. To be sure, the changes will be watched with eagle eyes in this vigorously competitive marketplace.

For the first time, the PIC has put the appointments to open tender. This is in line with the mandate it received last June from the Government Employees Pension Fund, by far its largest client. Of the R787bn in assets under management by the PIC (at conclusion of its most recent year-end), 92% were assets of the GEPF. And of the R787bn, 48% was in equities almost exclusively belonging to the GEPF.

The latest GEPF annual report, to end-March 2007, shows that expenses of R406m were “incurred in managing investments”. There’s no indication of the all-inclusive amount paid by the GEPF to the PIC, which in turn doesn’t reveal the all-inclusive amounts paid to the external managers.

Two years ago the PIC adopted a “core satellite” approach to its equities portfolio. It would be split for 75% to be passively managed internally, and the balance to be actively managed by “satellite” (external) managers. Each would now be tendering to manage a chunk of the 25% balance; an amount of around R100bn.

Even cut a dozen ways, it’s no small beer to any of them. On a rough count, assuming they earn on average 20 basis points (0,2%) for the active management only (excluding brokerage and the like), a pot of some R200m seems to await.

Various other things have changed too. They’ll no longer be drawn from among the life offices exclusively, and there are many more asset managers today than then that have the capacity to handle portfolios of this magnitude; Allan Gray, Cadiz African Harvest, Coronation, Foord, Investment Solutions, Investec and Metropolitan spring readily to mind. There are also empowerment credentials to be considered; probably, too, some of the newer but smaller black-owned firms will be in line for a leg-up.

In whichever way the PIC decides, controversy is perhaps inevitable. Those who get the bigger allocations will be happier than those who get the smaller, and those who get none won’t be happy at all.

Depending on how the pie is sliced, and for whom, the PIC will have a devil of a job in justifying its selections. First, it will need to show the basis on which it adjudges best of breed to award one asset manager more than another. Second, it will need to demonstrate its objectivity.

For the PIC is itself not a disinterested party in asset managers because it is heavily invested in companies that own several of them. The more work that goes their way, the better for the PIC’s investments in them.

The PIC’s annual report shows three such companies among its top 40 JSElisted equity shareholdings. These are Metropolitan, Standard Bank and Investec. They are ranked in the table by the percentages of their equity that the PIC holds – respectively 14,8%, 12,1% and 12% – not as percentages of the PIC’s total equity portfolio.

So, in money terms, the PIC would have a much larger exposure to, say, Standard than Metropolitan or, for that matter, to other financial-sector companies that don’t make it onto the table, such as Old Mutual, FirstRand and Absa.

In addition, the table only shows the PIC’s direct equity shareholdings and not its indirect. For instance, it would have a higher overall exposure to Investec because of the PIC’s financial support for the banking group’s empowerment transaction. It was concluded in 2004, at R90 per Investec share (fortunately, hedged on the downside by derivatives), and funded on an eight-year basis.

Relative to competitors, this might well stand Investec in good stead with the PIC. The group’s black ownership, according to its Financial Sector Charter report, is 25,1%.

Another interesting implication from the table is that these top 40 shares are registered in the name of the PIC, not the GEPF. This might not have much practical significance, except to differentiate between who’s the activist and who’s the proxy on corporate engagement and social responsibility.

The GEPF is a founder signatory of the United Nations Principles for Responsible Investment, followed later by the PIC (TT April-May ’07). When the GEPF originally signed the Principles, in April 2006, it was suggested that the GEPF would assume rightful ownership of the shares so that it could fulfil its activism commitment.

But with the shares still registered in the PIC’s name, it’s uncertain how the GEPF can conduct the leadership its founder role intended. Similarly obscure is to determine between client and service provider – a host of asset managers have also signed, subsequent to the PIC – who’s liable for what in setting examples of best-practice corporate governance that the Principles require.

Lastly, the PIC has made a R163m after-tax profit. Almost all of it is attributable to government as the PIC’s sole shareholder. There is an argument that the profit should be passed to the 1,3m members and pensioners of the GEPF, not to the fiscus, for payment of enhanced benefits; alternatively, that the PIC should make no profit to which fund members indirectly contribute.

True to the accountability and transparency it requires of others, the PIC will doubtless handle scrutiny with aplomb. When it comes to the allocations for external asset managers, there’ll be scrutiny aplenty.

How the PIC works

Daniel Matjila

Matjila . . . cool appraisal

So vast are the assets under management of the state-owned Public Investment Corporation that the way in which they are managed affects significantly not only its clients, particularly the Government Employees Pension Fund, but also the JSE as a whole. In this interview, PIC chief investment officer Daniel Matjila discusses past performance of the external managers and explains the new process by which they will be appointed.

It’s virtually certain that there will be more external managers than previously for a quarter of the R350bnplus equities portfolio that will be actively managed, and certain that they’ll be obliged to follow the UN Principles for Responsible Investment, of which the GEPF was a founding signatory. This implies renewed emphasis on shareholder activism by the managers as the means to promote companies’ compliance with the Principles. An announcement of the winning tenders is imminent.

Question: Who were the external managers for the year to end-March 2008?

Matjila: Futuregrowth Asset Management, Old Mutual Investment Group (South Africa), RMB Asset Management, Sanlam Investment Management and Stanlib Asset Management.

How did they perform in absolute terms and relative to one another?

As a composite portfolio for the year to end-March, the managers underperformed the benchmark by 2,79%. The best-performing portfolio had an outperformance of 0,71% while the worst-performing portfolio underperformed the benchmark by 5,25%.

How did their performance compare with the performance of the PIC in respect of assets managed by the PIC?

The internally managed equity fund underperformed the benchmark by 0,15%.

How were the external managers selected? How much of the portfolio was given to each for management, and on what basis were the respective amounts decided?

The allocation was done in 1996 through a closedtender process. Only the life-assurance houses with asset-management operations were chosen.

The PIC has “initiated the tender process for appointing external managers to manage the active (25%) component of the equities portfolio”. If there will now be a different tender process, how will it differ?

We have done an open-tender process. All asset managers were invited to participate.

What are or will be the major criteria of the PIC in awarding tenders?

Investment performance, process and portfolio construction; broad-based black economic empowerment; organisation and people; administration, trading, cash-flow management and risk management.

To what effect was the PIC, again to quote from the annual report, “overseeing the criteria and process for the selection of external investment managers” and “overseeing the process for establishing and monitoring the mandates of external investment managers”? What defects were revealed, or was the PIC happy with them all? Which managers performed better, and which worse, in terms of the criteria and mandates?

There were no defects revealed. Since the process has not been concluded, no information with regard to individual managers can be made public.

How did the mandates differ previously, and how will they differ in the future?

The current mandates are general-equity mandates. The new mandates will, in addition, also include specialist-industry mandates such as resources, financials and industrials.

Why does the PIC need or want external managers at all?

The internal portfolios are passively managed. It is anticipated that a well-diversified blend of active external managers can enhance the performance of the fund.

Are the external managers obliged to adopt PIC policies in respect of proxy voting, including public disclosure of such voting?

Yes.

What is the rationale for 75% of the equities portfolio being managed passively? In current market circumstances, is the PIC contemplating a review of this strategy?

The GEPF mandate is based on a core satellite approach with the core being managed on an enhanced-index basis and the satellites on an active basis. Research has shown that, from a risk/return perspective, the 75/25 ratio is optimal.

When is it expected that the process to select satellite managers will be concluded?

During the 2008-09 financial year.

Who will ultimately decide on the tender awards? Will it be the PIC exclusively, or will the decision be made in agreement or consultation with PIC clients?

The PIC will award the tenders based on the outcome of the process described above.

To what extent does the PIC rely on external advisers, such as multi-managers, in making these awards? Is it simply guided by them, with a discretion to override their advice? If so, on what sorts of criteria would this discretion be applied?

The PIC does get external advice but decision making lies with us. The PIC appointed Advantage Asset Managers (a multi-manager) to assist with the evaluation and selection process. The process mentioned above was followed in a disciplined fashion. Its outcome was clear and acceptable.

How might the PIC overcome possible conflicts of interest, ie by not favouring external managers in whose companies it is significantly invested?

The allocations are determined by finding an optimal mix of managers that comply with client’s risk parameters.

Of the PIC’s R350m management-fee revenue in 2008 (R112m in 2007), was any proportion paid to external managers or was this amount for the PIC alone? If the latter, how is it justified in terms of the larger proportion of the portfolio being passively managed?

The fee earned is not only in respect to the equity portion of the fund managed by the PIC, but rather in respect to all the assets under management.

How much did the external managers respectively earn, from their PIC engagement, in the 2008 financial year?

The fees are performance based. Underperformers have earned less and out-performers have earned more.

How are the management fees calculated? Is there an incentive for performance or penalty for non-performance? On what criteria is performance assessed? Is there a floor or ceiling of basis points for assets under management?

The manager earns a basic fee of 0,20%, which is adjusted up or down based on performance. Excess returns above the benchmark earn an additional 10% of the excess return up to a maximum of 0,25% while returns below the benchmark are penalised by 10% to a maximum of -0,10%.

Is it intended or anticipated that the new tender process will result in a reduction of the management fees’ computation?

It is anticipated that the new blend will perform better than the old blend. Consequently, it is expected that fees paid will increase.

How many external managers will be appointed for the 2009-10 financial year? Since the PIC is already halfway through its current financial year, when will they be announced?

This information will be made public as soon as the process has been completed.