Bonds and Prescribed Assets

NFB Asset Management’s Paul Marais suggests that investors concerned about prescribed assets should be thinking about pre-emptive measures.

Paul Marais

Paul Marais

Managing Director and Portfolio Manager

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Bonds and Prescribed Assets

Preamble: the key concept being that an attempt to get ahead of prescribed assets may allow investors to determine the price they pay for these assets; doing so after regulation is promulgated may take that price self-determination opportunity away as the market’s price discovery mechanism is likely to change significantly in respect of these assets; primarily due to artificial demand.

Embedded in the preamble is that prescribed assets are a legislative process. They are very unlikely to come about in the form of an edict so it is entirely possible to reasonably speculate about the legal form these might take and from there to determine which portion of an investor’s asset base is most likely to be affected. Two obvious pieces of legislation that could be amended to compel investors to purchase government-issued assets are the Pension Funds Act (PFA) and the Collective Investment Schemes Control Act (CISCA). Another form may be through the tax regime: perhaps by forcing investors to repatriate a portion of their offshore assets; specifically those done through the “asset swap” mechanism as these are technically still South African assets, but this is likely to be viewed as tampering with the exchange control regime and needs to be carefully considered. We think this avenue highly unlikely so the portion of investor’s asset bases most likely to be affected and therefore the legislation to be considered is very likely to be domestic-only.

Amending legislation is often, though it doesn’t strictly have to be, a lengthy, consultative process. That process is very likely to have already begun but there will still be a meaningful amount of time for investors to consider the implications for their domestic portfolios. In any decision-making process, time has value. This can be used to determine whether forthcoming legislation, if adopted, and the current price of prescribed assets are commensurate with each other. A luxury investors will not be afforded post-implementation.

Also likely to be included ahead of implementation is the exact nature of the assets being prescribed. This point often gets lost in alarmist conversations about prescribed assets. If the asset behind prescribed is SAA equity, for example, then that’s a very different thing from the prescribed asset being vanilla 10-year SA nominal government bonds. The former of which most investors are unlikely to want to own, the latter of which most of them already willingly do own and at yields two or three percent higher than they currently are, would probably quite happily own even more of. Try not to be suckered into the alarmist conversation until you know whether it is some bankrupt state-owned enterprise being forced on you versus something else entirely.

Determining the exact type of prescribed assets, however, requires a larger degree of speculation in order to get ahead at a price of the investor’s choosing. Doing so comes with a not insignificant amount of risk. With that caveat issued: our view is that prescribed assets are most likely to take the form of government-backed infrastructure bonds (perhaps even ESG-friendly ones focused on things like clean energy or ultra-low cost, widely available telecommunications). Whether these are inflation-indexed or not is more difficult to pin down. Inflation-indexation passes the inflation risk to government but potentially makes it easier for them to raise the required capital. If the asset is prescribed however, government will know they’ll get the assets they’re looking for so the real yield on these assets is likely to be lower than the market would have arrived at independently. So too will the nominal yield be lower than it otherwise would have been.

To get ahead of these potentially artificially lower yields, assuming that our view is correct that the type of asset most likely to be prescribed is some form of nominal government bond ear-marked for infrastructure development and that its likely to come through something like the PFA or CISCA, is somewhat challenging. If we drop the infrastructure element, it becomes far easier. If we add back in the time element then investors have the luxury of waiting for yields on government bonds already out there in the market to rise further, though we do note that they seem to have become more settled in the last six or so weeks, before they commit capital ahead of prescribed assets being enforced.

The following article on how investors might get ahead of prescribed assets was written for Citywire as a follow-up to our article on the investment case for South African bonds which can be found here.

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