Private equity and venture capital funds (‘private equity’) play a unique function in the investment marketplace because they are actively involved in growing companies and their workforces. This differentiates private equity from hedge funds, collective investment schemes and other institutional investors, which generally play no active role in the strategic growth of companies.
Despite this distinction, Regulation 28 – the part of the Pension Funds Act that specifies ceilings for exposures to different asset classes – currently places private equity in the same bucket of alternative investments as hedge funds, which is capped at 15% of compliant funds’ assets under management.
Considering that private equity focuses on the real economy and on building successful companies through a combination of capital and strategic know-how, greater awareness is required to enable pension funds to direct capital to private equity and manage their investments appropriately. Private equity offers pension funds attractive returns, the opportunity to diversify their investment exposure and facilitates sustainable and impact investing.
This matter is particularly pertinent now, seeing as measures that enable pension funds to increase their allocation to private equity would be highly supportive in confronting South Africa’s growing unemployment problem; fiscus shortfalls; gross domestic product contraction; the COVID-19 economic crisis and the recovery efforts thereafter; as well as the country’s broader development goals.
The Southern African Venture Capital and Private Equity Industry Association (SAVCA) has prepared a positioning paper, which outlines two proposed amendments to Regulation 28:
1. Separate hedge funds and private equity into independent asset classes, each with their own caps. This would enable investment decision-makers to model the asset classes independently in their portfolio construction process, so as to properly accommodate the risk/return characteristics of each, thereby evaluating risk-adjusted real returns.
2. Gradually increase the private equity cap from 10% to 15%. This step can be phased, allowing the industry and investors to scale up capacity in tandem, possibly by one percentage point each year. A gradual approach is also low-risk as unintended consequences can come to light before full implementation.
Increasing the private equity cap would effectively allow a pension fund to take a larger exposure to the entire asset class, enabling a higher degree of diversification. This offers positive public benefits by improving the overall financial security of pension fund savers in the long run.
We believe that a case can easily be made for an even larger increase to the private equity cap, however, we respect that regulators should take a gradual approach to expanding exposure – particularly as pension funds will need to develop the skills to analyse the asset class and the supply side may need to increase capacity.
More details are contained in the positioning paper which can be accessed here.