South African asset managers are divided on the merits of including Naspers in retirement scheme portfolios; and though for most the answer is ‘yes’, there is division on the level of exposure, ultimately leaving trustees with the burden of making this complex decision.

Trustees are not typically involved in selecting shares for their members’ portfolios (they outsource this to asset managers), but because Naspers has such a heavy weighting in the FTSE/JSE All-Share Index, some managers have been referring back to trustees for their view of how it should be handled.

Certainly, with its substantial exposure to global tech and to China through Tencent, Naspers has provided a unique opportunity to grow pensioner wealth. Over ten years from 2007 to 2017, R100 million would have increased to R2.3 billion, a return of 23 times.

Xiaogang Zhang, portfolio manager with Greenwoods Asset Management, one of the largest Chinese fund managers specialising in managing Chinese equity funds, believes there is plenty of evidence to suggest that Tencent’s growth story will continue well into the future. A Chinese national, Zhang himself admits to spending close to four hours a day interacting on his mobile phone through Tencent’s applications and says this amount of time is average for most Chinese. Greenwoods Asset Management have a substantial holding in Tencent in their China equity funds.

Over the short-term, Tencent is the dominant PC/mobile game distributor and developer, with over 50% of its revenue coming from this source.

“While some analysts believe that growth in the Chinese game sector is set to slow, Tencent has many other avenues that have the potential to provide significant growth.”

To give a sense of this, using brands SA internet and mobile users are more familiar with, Tencent owns the equivalent of Facebook, Whatsapp, Bing, Paypal, Netflix, Supersport, Apple Music and MPesa in China. Users of these platforms are fast approaching the one billion user mark, roughly three times the level seen in the US, but most are nowhere near their potential for monetisation based on their US counterparts. Locals suggest that, under Xi Jinping’s rule and the China Belt and Road initiative, having the largest company in the world by market cap could be an unstated but important milestone on the road to global economic might.

“However, despite its Tencent holding and the dominance thereof in the Naspers share value, some managers cite valuation and governance risks as significant issues and prefer to avoid investing.”

They feel that Tencent is priced for perfection (which rarely pans out) and that there are weaknesses in the other companies that make up what is known as the ‘rump’ of the Naspers portfolio. Many of these other companies are currently loss-making and need to be propped up by constant capital injections until they may someday be successful. Naspers appears to be increasingly reliant on the Tencent dividend to meet these cash needs and cash returns have been declining.

On the corporate governance side, there is the issue of the dual-class share structure that allows only a small group of historical shareholders to control the majority of voting rights. This is a source of significant frustration for most of the remaining shareholders, and there is mounting pressure on management to dissolve this. Then there is the fact that foreign shareholders can only invest indirectly into Chinese internet and media companies through what are known as variable interest entities, which means that Naspers does not actually have typical ownership rights in Tencent and, in particular, has no claim on its assets. It only has contractual rights to Tencent’s earnings and dividends. The November issue of The Economist called variable interest entity structure ‘A legal vulnerability at the heart of China’s big internet firms’. The risk is that at some point there could be a regulatory shift against these structures.

“Other asset managers are prepared to focus principally on the benefits of the Tencent exposure and pay less attention to the ‘rump’. They say that South African investors are fortunate to be able to invest in Tencent, which they believe has a long ‘runway’ ahead of it because of its strong strategy and ongoing diversification into different revenue streams.”

Until recently, the most common index used as a benchmark for retirement funds is the FTSE JSE Shareholder Weighted Index (SWIX). The SWIX takes into account only those shares that are available to trade and are registered on the SA share register, i.e. in theory it excludes strategic and foreign holders of the share. As a benchmark, it has an exposure to Naspers of around 24%.

In terms of how much exposure to Naspers managers are comfortable with, some use the FTSE/JSE Capped SWIX All-Share Index (Capped SWIX) as a benchmark. This index imposes a 10% limit on the weight of any single stock. Why 10% you may ask? To manage the specific risk that a higher exposure would bring to the portfolio, is the most cited response, though this does not explain why 10% and not 7.5% or 15%, for that matter. Assuming a typical South African retirement fund investment portfolio holds around 50% of its assets in South African Equities, the Capped SWIX would imply a 5% exposure to Naspers in the portfolio. Regulation 28 of the Pensions Fund Act limits holdings in any single share to 15% of the portfolio, a limit that would only be reached if Naspers was 30% or more of the equity portfolio of the hypothetical portfolio considered above.

For a share with a track record of nearly doubling every two years over the past 10, the choice between capped SWIX and SWIX could have a meaningful impact on retirement savings. Perhaps even more bizarrely this outcome is tied more to the habits of Chinese internet users and the whims of the Chinese government, than to our own people and government here in SA.

– Malcolm Fair
Managing Director

*This article originally appeared in Business Day on 23 February 2017.