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50 years of investing in an evolving ecosystem

The asset management industry plays a key role in society, channelling capital from savers to where it is needed in the real economy, and in so doing, creating returns on this capital that will help sustain these investors in retirement. Achieving this goal is not possible without healthy competition, a supportive regulatory environment and continuous improvement and professionalisation. Tamryn Lamb outlines the trends that shape the industry.

Over the past 50 years, the South African asset management industry has evolved substantially. When Allan Gray was founded in 1973, the industry was grappling with increasing prescribed asset requirements as the government sought to fund budget deficits, the aftermath of a stock market crash in 1969 and rising inflation and interest rates. Today, and despite not growing in US dollar terms over the last decade, the South African pension market is ranked 11th largest in the world. Excluding the Public Investment Corporation (PIC), and the life insurers, we estimate that the total size of the private asset management industry is c. R6tn.

A great quote (often incorrectly attributed to Darwin) states that it is not the strongest of the species that will survive, nor the most intelligent, but the one most responsive to change. The same can be said for our industry. Despite a changing, often tumultuous backdrop, the industry has adapted and is more robust as a result. That said, while adaptability is indeed critical to survival, so, too, is having an approach and organisational structure that endure and evolve, but ultimately prove resilient, as Duncan Artus discusses in his article.

Below, I discuss four key trends that have moulded the industry over time – and will likely continue to do so.

… regulation can help influence better investor behaviour – which ultimately influences outcomes.

1. Investment paradigms and the impact on investor preference

One way of thinking about the investment landscape is that it is characterised by different paradigms, and that each paradigm has a different regime or set of rules that is influenced by a number of factors, including political and social factors.

Allan Gray was founded in a period when the paradigm rules were not too dissimilar to today: rising inflation and an uncertain political backdrop. We subsequently shifted into periods of low interest rates and low inflation, followed more recently by a return to higher inflation and interest rates, and a rise in geopolitical conflict. We have also witnessed multiple bubbles and crashes, including the Japanese bubble of the late 1980s, the emerging market crisis in 1998, the dotcom bubble in 2000 and the global financial crisis in 2008.

Changes to these paradigms can be sudden and dramatic, but are usually slow and hard to predict. While we don’t focus our attention on making macroeconomic predictions, understanding the rules of each time is important for two reasons. Firstly, because the environment dictates the available opportunity set, both what to buy and what not to buy. A perfect illustration of this is that the top 10 global stocks at the top of each market cycle over the past four bubbles have been different – and typically the ones not to invest in over the following decade!

Secondly, the rules of the paradigm tend to have a meaningful – but often underappreciated – impact on investor behaviour. We often anchor to what prevailed in the last regime, and risk appetite fluctuates alongside broader market pessimism or optimism.

We often anchor to the paradigm that prevailed in the last regime, and risk appetite fluctuates alongside broader market pessimism or optimism.

As an illustration of this, analysis from the Allan Gray platform shows that investors who started investing with us in 2005 have a higher allocation to South African equities than those who started in 2019, despite having similar risk profiles and objectives. This is likely due to the much better equity performance in the early 2000s than in the five-year period pre COVID-19.

This on-off appetite to invest in equities is also evidenced in the overall industry flows. Our analysis shows that an investor contributing 15% of their salary for 40 years needs to maintain at least 60% exposure to equities to have a greater than 80% chance of sustaining their income in retirement. Yet, investors have gravitated to lower-risk solutions, like income funds, over the past 10 years.

It is not just the investment backdrop that has changed over time; exchange controls have also been changed and liberalised. Over the last 30 years, the allowance to invest offshore in a Regulation 28-compliant, multi-asset or equity portfolio has increased from 5% in 1995 to 45% today. As we have outlined previously, we welcome this additional opportunity to diversify our clients’ portfolios, but as with any investment decision, it should be carefully scrutinised and considered as part of a holistic portfolio construction process.

2. Regulation: Transitioning from rule- to principle-based

The South African regulator has been focused on mitigating risk (preventing failures), strengthening consumer protection and keeping in line with global best practice. Regulation, when designed well and implemented effectively, should boost confidence in the overall sector and is therefore a critical component of our industry. Of course, effective design and implementation are key, and sometimes there is a disconnect between the impact of the regulation and the intended outcome.

In an economy with high levels of unemployment and wide income disparities, the problems are multifaceted and cannot be fixed by regulation alone. However, regulation can help influence better investor behaviour – which ultimately influences outcomes.

Over the past two decades, there have been two shifts in the South African regulatory landscape that are important to be aware of as they will likely shape the market and behaviour for many years to come.

Firstly, South Africa has followed global peers in adopting the so-called Twin Peaks model of regulation, which divides regulatory duties between two separate regulators, namely the Prudential Authority (under the South African Reserve Bank) and the Financial Sector Conduct Authority (FSCA). The Prudential Authority regulates institutions like banks and insurers and is tasked with ensuring and promoting safety and soundness and financial stability. The FSCA regulates institutions like pension fund administrators and pension funds and is responsible for ensuring the efficiency and integrity of financial markets and promoting fair treatment of consumers by financial institutions.

The second major shift is retirement reform: Since 2012, the South African retirement fund regime has been undergoing fundamental reforms with the goal of promoting savings and increasing preservation, harmonising treatment across products to minimise complexity and improve overall governance. Despite being the 11th largest pension system globally, we are ranked one of the lowest in terms of the level of benefits and outcomes provided by our pension system for our retirees, according to the 2023 Mercer CFA Institute Global Pension Index.

 … the role of advisers will – in our view – continue to be instrumental in ensuring a healthy overall savings environment.

While some reforms have already been implemented (e.g. harmonisation and defaults), one topical change lies ahead in the implementation of the so-called two-pot retirement system. With this change, the regulator is trying to solve two problems: allowing individuals in financial distress some flexibility to access their savings without forcing them to resign or retire, and promoting preservation of retirement savings. Balancing the need for short-term flexibility, if required in an emergency, and the need to promote better long-term outcomes is tough to get right. However, it will be critical for these reforms to have their intended positive impact.

It will be incumbent on all industry players to understand the implications of the new rules, design solutions that not only comply with the new rules, but also continue to promote long-term retirement savings, and communicate accordingly to investors, who will need to remain focused on their long-term objectives.

Although there are over 5 000 active private pension and provident funds in South Africa, the 100 largest private retirement funds hold approximately 80% of pension assets. The increase in regulation has played a role in driving the migration of funds to umbrella solutions, which now comprise c. 46% of private retirement funds, compared to 39% in 2015. We expect this trend to continue, which will amplify the need for greater transparency across umbrella providers and simply designed default solutions.

3. Competitive dynamics across the industry

Our founder, Allan W B Gray, used to say that “complacency and arrogance are our worst enemies”. While this mindset is embedded in how we run Allan Gray, operating in a highly competitive environment helps. For investors, a healthy degree of competition is positive as it helps raise the bar for all participants, promotes transparency and tends to drive down overall costs.

The asset management industry was initially dominated by the life insurers in the 1970s, who were largely managing on-balance sheet pension and endowment products. This slowly changed as independent asset managers, such as Allan Gray, built trust and confidence with clients. This picture does not stay static, and the industry has continued to become more competitive and less concentrated over time.

According to an Alexander Forbes survey, the top 10 asset managers in 2006 (ranked by assets under management) managed 89% of assets, compared to c. 72% at the end of 2022. In addition, not every manager survives the test of time. Of the 23 managers listed on the Alexander Forbes Survey in 1992, only six remain in their original form.

A discussion about competition would be incomplete without referring to the rise of passive investing, which enables investors to track specific index investments. Globally, passives have been a significant disruptor, increasing to c. 46% of long-only assets under management. Growth in passives in South Africa has been slower, currently comprising roughly 8% of unit trust assets under management. While we expect this to increase, the slower growth to date is perhaps unsurprising when considering that the FTSE/JSE All Share Index is highly concentrated, with the top 10 shares equating to just under 50% of the index.

A hallmark of healthy competition is greater transparency over time, particularly regarding cost disclosure. This has been evidenced through developments such as the standardisation of voluntary, but well-supported disclosure standards like the effective annual cost (EAC) standard, which allows advisers and clients to compare charges across retail investment products. Investment management fees and platform administration charges have also declined over time.

We commit to continuing to act responsibly through promoting transparency and a long-term orientation, and by firmly keeping client interests at the centre of all we do.

We expect the environment to continue to evolve, with technology playing an important role in both enabling and disrupting business models. Historically, one could derive a competitive edge in investing by simply uncovering information that was not readily available. In today’s environment, that edge is arguably derived by cutting through the noise created by the sea of information that is all too readily available, to focus only on what is relevant for long-term decision-making.

4. The role of intermediaries, advice, and distribution

We operate as part of a financial ecosystem, with market players interacting, competing, and collaborating to offer services to clients. A critical link in this ecosystem is the role of advice. In the retail savings market, growth in the investment platform market has supported the growth in the advice market, as more fund and product choice has been made available, alongside the ability to blend these funds into solutions that meet specific client needs.

The advice industry continues to evolve from being product-led to making the client’s life the centre of the conversation. While disruptive technologies and continued regulatory change present challenges, the role of advisers will – in our view – continue to be instrumental in ensuring a healthy overall savings environment.

The role we play

As we reflect on our 50-year milestone, I am reminded of the saying that “the more things change, the more they stay the same” (French writer Jean-Baptiste Alphonse Karr). Our job is to navigate this changing environment, and to evolve and improve alongside it, but at the same time to remain true to the principles and fundamentals on which the firm is built.

We operate within the investment ecosystem, which needs to be in sound health if we are to deliver on our goal of creating wealth on behalf of our clients. We recognise the important role that each member of this industry plays in pursuit of that goal. We commit to continuing to act responsibly through promoting transparency and a long-term orientation, and by firmly keeping client interests at the centre of all we do.

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