For the first time, a South African tax commission recommended taxing some income of pension funds.
The Katz Tax Commission recommended a 30% flat tax be imposed on interest on fixed-income investments; rental income from properties; and "trading" income, which is income from handling ancillary services, such as operating a salary payment system.
The recommendations, made earlier this month, are part of the commission's broader mandate to study ways of restructuring the tax system.
South Africa's Parliament will begin hearing evidence on the proposals in mid-January, and as of now, tax proposals would be introduced as part of a reading of the national budget March 13.
The tax proposal should meet with strong opposition, which might derail it, said Jurie Wessels, executive director of the Life Offices Association, an insurance industry trade group in Capetown. But eventually, he expects "something will pass," although perhaps not levels as high as 30%.
All the same, the South African stock market already has gained on news of the recommendations - while the bond market fell. As Mr. Wessels explained, "if this goes through, fund managers will move (more heavily) to quoted shares in which capital gains and dividends are both tax-exempt."
Already, South Africa's pension funds have an average 66% weighting to equities. South Africa's Financial Services Board - "an ERISA-like organization" - recommends local pension funds should not invest more than 75% of their assets in equities, said Graham Dickason, general manager, investments, for MPF Management Services (Pty) Ltd. in Johannesburg. Life Office's Mr. Wessel expects that if taxes on interest income and rentals take effect, funds would move up to the 75% limit on equities and "ensure that they would always stay at that ceiling."
In contrast to this bullish domestic view, quite a few foreign investors sound less enthused about South Africa's market - at least for 1996. One reason is the market boom - through Dec. 14, the South Africa market advanced 18% in U.S. dollar terms, according to the International Finance Corp.'s Composite Investible Index of emerging markets. That makes South Africa the second best performer of the 26 markets in the IFC index.
As a result, quite a few international money managers expect other emerging markets, especially some of this year's laggards, to outpace South Africa in 1996.
What's more, at least some passive emerging markets investors evidently will have to sell some of their South African shares. The IFC will change its index weightings effective Jan. 2 on a number of markets in its indexes, including South Africa.
The South African weighting in the composite investible index will drop to 18.9% from the current 25.7%. The market's regional weighting also drops to 72.1% from the current 78.4%. (The South Africa weighting in the Morgan Stanley Capital International Emerging Markets Free Index remains at 15.9%; and the weighting in the Baring Emerging Markets Index will stay at 13.8%.)
According to Stuart Peskin, vice president in the Atlanta office of State Street Global Advisors, the IFC index change on South Africa "is a big problem for those using the IFC's market cap weighting." These investors will "have to (lower exposures) to a market" that had just become part of the index about nine months ago, he said.
But many of State Street's indexed emerging markets portfolios may not be affected. According to Mr. Peskin, about two-thirds (of the just more than $1.5 billion) of the firm's passive emerging markets assets are not indexed using market capitalization and do not have as high a weighting to South Africa as the IFC's investible index.
While the remaining one-third is passively managed using the IFC investible index, State Street will try to avoid actually selling the excess South Africa shares. According to Mr. Peskin, "the majority of selling we do in South Africa will be absorbed internally. Clients who want to gain exposure to South Africa in a global emerging markets mandate can buy South Africa shares from clients" who are invested in the market-cap-weighted emerging markets index, he said. Thus, "we expect to unload very little, if any, South Africa stock," he said.
In contrast, active emerging markets managers believe they won't be affected by the shift in the IFC's South Africa weighting. Few, if any, of the managers now have anywhere near 25% in South Africa - which is the IFC investible index's exposure to South Africa.
"Most managers would not have more than a 5% weighting in South Africa," said Jean De Bolle, global portfolio manager for Foreign & Colonial Emerging Markets Ltd., London. Therefore, the IFC's change "will not have any impact on the market."
Managers' views on the attractiveness of South Africa also differ. One camp, which includes Foreign & Colonial's Mr. De Bolle, believes South Africa's market has become "fairly priced" after this year's gains; as a result, some of this year's laggards, including those hurt by the late 1994 Mexican debacle, appear more attractive. For its part, Foreign & Colonial plans to keep its South Africa exposure at 8% of its $1 billion in global emerging markets funds, said Mr. De Bolle.
Blairlogie Capital Management, Edinburgh, Scotland, also doesn't plan to change its South Africa weighting - which is 10.2% of the $72 million Blairlogie Emerging Markets Fund. Gavin Dobson, chief executive officer, sees some brighter prospects elsewhere.
While South Africa should turn in a 3.5% economic growth rate next year and about 18% earnings per share growth, the firm expects earnings per share growth next year of 28% in the Philippines, 25% In Israel, 32% in Mexico, 34% in Brazil, 21% in Chile and 25% in Peru.
But some interested investors have not yet moved into South Africa. Among those are Edinburgh Fund Managers, Edinburgh. That firm expects to begin investing in South Africa next year if its emerging markets fund is "up and running," said Jim Robertson, investment manager for Africa. "I think our weighting will be about the level of the IFC." he said.