Edition: December2015 / February 2016
One size doesn’t fit all default portfolios. Treasury must think again
on private equity, hedge funds and especially infrastructure.
In its seminal 2011 policy document on better financial services, National Treasury repeatedly
and rightly expressed its concern over the “high
and opaque” fees being charged by product providers
to product consumers. Its latest batch of proposals to
address them can throw out a robust baby with the
“Performance fees are not permitted in default
investment portfolios,” states Treasury bluntly.
This mooted prohibition should make investors
sit up sharply. A blanket ban on performance fees
can suffocate private equity and hedge funds, both
permitted if not encouraged by Regulation 28 to
comprise cumulatively up to 15% of pension funds’ portfolios.
The rationale is to allow greater diversification
of asset classes and hence a wider spread of risk.
But insist on the wholesale ban and Reg 28, which
guides pension funds’ prudential requirements, is
undermined. Unlike investment in equities and bonds,
where managers can accrue performance fees for
tracking an index, such fees are integral to private
equity and hedge funds.
Also potentially ominous is application of the
ban to “other assets”, capped by Reg 28 at 2,5% of a
fund’s portfolio. To the extent that this category refers
to direct investment in infrastructure projects, the
impact can only be negative; not least for the National
Development Plan’s emphasis on job creation, services
provision and gdp growth.
Pension funds have the wherewithal and the need
to go big-time for infrastructure because of the perfect
fit between this macro-economic priority and the
investors’ long-term focus. Arguably, infrastructure
should not merely be slotted into “other” but
categorised as a separate asset class.
It offers pension funds further opportunities
for portfolio diversification as well as returns
that tend to be stable and predictable. As it stands,
Reg 28 provides generously for investment in debt
instruments – like government and governmentbacked
paper – that might or might not find their way
to infrastructure and that might or might not face
But to get the boost needed, pension funds
should be stimulated to invest directly in specific
projects where they have ‘line of sight’ participation
from inception to conclusion. As renewable energy
and similar high-impact projects are initiated by
the private sector, investment opportunities will
Managers must be remunerated, clearly on a
basis dissimilar from index tracking. However, a
problem with performance fees is that they lack
standard definition. Particularly when it comes to “alternative investments” (as Reg 28 categorises private
equity, hedge funds and “other”), the meaning and
quantification of performance fees can differ from
investment to investment. This is because they’re
usually subject to negotiation; for instance, on the
various levels of performance at which the fees kick in.
Van Wyk . . . slow take-up
In taking aim at all performance fees, the
consequence – surely unintended – is for National
Treasury to erode objectives that it had legislated by
Reg 28 for support by pension funds of “alternative
investments”. This is unmitigated by restricting the
ban on performance fees to default portfolios only. For
it’s safe to assume that the preponderance of portfolios
will be defaults.
From the perspective of National Treasury, the
ban on performance fees in default portfolios seems
logical. Defaults are there, amongst other reasons,
to provide for simplicity of choices. Were these fees
to apply, and transparently disclosed, the simplicity
intended would be defeated.
For purposes of Mr Average Fund Member and
probably also Mr Average Fund Trustee, simplicity
is virtually unachievable. Moreover, comparison of
apples and pears is pointless. Thus much of the logic,
in excluding performance fees from default portfolios,
The so-called “opaqueness” of performance fees is
not, or not necessarily, due to managers trying to line
up consumers for rip offs. It’s because, by their nature,
the methods used for the calculation of performance
fees are complex. They vary in terms measuring risk
against return, the benchmarks applied, respective
funds’ mandates to asset managers and so on.
Take private equity. Broadly, the manager would
charge a base annual rate at one or two percentage
points of the assets. He’d additionally receive
performance fees (known as the “carry” or “carried
interest”) once agreed return targets (“hurdle rates”)
have been achieved on a successful exit from the
investment. Carries and hurdles defy standardisation.
Private equity has begun to flourish in SA. The
more it supports venture capital, the better for
Infrastructure investment by pensions funds,
however, is far from outgrowing the imposed 2,5%
cap. Mark van Wyk and Kasief Isaacs of Mergence
Investment Managers estimate that it still represents
less than 0,3% of financial institutions’ total asset
allocations. This, they say, is despite SA having about
R4 trillion in its long-term savings pool and despite
government claiming that it has over 600 “shovelready” programmes awaiting implementation.
Arguing in a Glacier by Sanlam research report,
they advise trustees: “The first step in making an
allocation to infrastructure is to determine what
role (it) should play within the portfolio. Once the
investment-policy statement has been amended
to adjust for the expanded investment universe, a
holistic look can help determine how to invest in the
asset class. Areas to emphasise involve alignment of
interests with managers....”
Back to National Treasury. Rather than an outright
prohibition for default portfolios, it could consider
instead a cap on performance fees across all portfolios.
This might be preferable to it countering objectives
that caused it to revise Reg 28 in the first place.