Issue: September-November 2011
Editorials

NATIONALISATION 3

You will be hurt

Were mines and banks nationalised today, what would be the effect on members of pension funds? TT asked ROWAN BURGER, head of investment strategy at LibFin, to apply his actuarial skills in compiling a hypothetical exercise.

The impact of nationalisation proposals will be felt by owners of capital which includes members of pension funds. Understanding the financial impact may result in a different approach to achieve better outcomes for employment creation and for dividing profits between labour and capital.

Central assumptions in these calculations are that, in the nationalisation of JSE-listed mines and banks, shareholders will be compensated at 50c in the rand for their holdings and that funding for this compensation will be raised in the debt market.

Impact on listed shares

Basically, SA mines and banks would see their share prices halved. For companies with global operations, we proportioned the effect by SA revenue to global revenue (although recognising that current share valuations have probably priced in the uncertainty of tenure). A pension fund member's holding of shares in the SWIX40 (the JSE's share-weighted index of the top 40 shares) will reduce in value by about 15%. These shares normally comprise around 65% of pension funds' portfolios.

Impact on other investments

At the same time, to fund the compensation SA will have to raise a significant amount of debt internationally. This will cause an immediate increase in bond yields, as a result of the increased supply of debt instruments and heightened political risk, of say 2% across the curve. This roughly translates to a 10% decrease in value of the fund member's bond holdings. Bonds normally comprise around 25% of a pension fund's portfolio.

Where pension funds have no offshore investments, assumed in this example, they won't benefit from a significant rise in their rand values. This rise will occur as the rand weakens in consequence of the expected payments due to foreigners and an increase in SA's risk premium.

We haven't considered second-order impacts.

Future returns

The biggest effect would be to future expected returns. SA investors will have a vastly diminished investment universe of mainly industrial funds, a few insurance companies and the remaining foreign operations of miners and banks should they choose to remain listed on the JSE.

Interest rates will go much higher, increasing the cost of capital. This will cause economic growth to contract, affecting jobs, and similarly reduce the potential for companies to develop, affecting profit levels and hence dividend payments to shareholders.

Expected future returns to pension funds could therefore reduce, conservatively, by one percentage point a year.

Impact on an individual saver

Take a pension fund member entering the workforce at age 25 and retiring at 60. Each year he's contributed a full 15% of his salary to retirement savings. On these savings he's earning 4% real but life-staged from age 53, thus expecting a pension at retirement of 70% of his pre-retirement salary. (This 70% is known at the NRR, i.e. the net replacement ratio, being the percentage of salary before retirement received after retirement.)

  Base Case Hit at 30 Hit at 40 Hit at 50
NRR 70% 44% 54% 56%
Contribution required post nationalisation to achieve NRR of 70% 15% 23,6 23,7% 31,6%
Implicit nationalisation saving tax   8,6% 8,7% 16,6%

The above nationalisation scenario would impact on the fund member at different life stages as follows:

The extra contribution required could be considered an additional tax on the member for him to return to his equivalent NRR position.

Given the recent proposal to cap tax deductibility at 22,5% of the savings contribution, the required contribution of all ages would be greater than this maximum. On this basis, a fund member who is today 50 years old (and has a 35% tax rate) would now have to contribute 36% of total salary if he wants (and can afford) to get back to where he was before nationalisation.

At the younger ages it is the diminished future return that has the greatest impact (as the reduction of 12,5% on the accumulated retirement savings happens on a lower capital base). In the case of older workers, they simply do not have the remaining employment period to recover the shortfall created. Without a reduction in future returns, the 40 year-old would have to contribute an additional 2,7% of salary to retire on the intended NRR target of 70%.

Who pays the cost for what benefit?

The analysis shows that it is the general worker who is most likely to be worst hit by nationalisation. Yet it is the same person whom the proposals are looking to benefit. The reality is that the workers are the owners of capital by virtue of their retirement savings. It means that workers need to assert their rights in terms of how managers of companies act as agents of their capital to ensure the best possible outcomes not only for themselves but also for SA's many unemployed.

Trustees should apply their minds to these considerations when mandating their investment managers.