The toxic political atmosphere in which the Steinhoff disaster has unfolded has caused some people to lose their minds. It’s almost as though accounting frauds are not an inherent part of investing, and company collapses never happen. People seem to have forgotten basic portfolio theory — that investing is about managing unknowns.
On average, equity investments provide a better return than lending money to companies. This has to be true or else we’d never do it. Equity finance provides a shock absorber for the overall financial system as the varying performance of companies can be absorbed by investors. Like our pension funds, equity investors consciously take on this risk. The company they are backing might be a dog, but the averages make it worth it.
An average accommodates a wide distribution. One company can collapse into worthlessness, while another can multiply its value tenfold. It is hard to tell the difference between the two in advance.
Some factors are unpredictable and beyond our control, including when the company management is running a sophisticated fraud.
So we spread our eggs across many baskets, taking the good with the bad. We might end up with middling returns, but we avoid the existential risk that would come from trying to pick particular winners.
Steinhoff made up about 3.3% of the JSE’s Swix 40 index. For a portfolio invested to match the index, the collapse of Steinhoff reduces its value by a few percent. That’s painful, but not outside the range of returns volatility such a portfolio would experience daily.
Steinhoff’s market capitalisation has lost a staggering R180bn of value, but the loss for a well-managed portfolio is no black swan.
The Government Employees Pension Fund (GEPF), for example, had only 0.6% of its assets in Steinhoff. Daily political announcements have a far greater effect on the value of the GEPF than Steinhoff does.
While it is hard to pick winners, it would be bad for all investors if no one tried. In the case of Steinhoff and, frankly, every company, some got it right and others didn’t. Some commentators have made out that active investors were simply sitting on their hands but several interrogated Steinhoff and had a reasonable basis to invest.
There were no obvious signs of accounting fraud in the company’s financials. Those same investors have got it right on other cases.
On the other hand, there were some who did detect problems and largely avoided the company, such as Futuregrowth, Prudential, 36One Asset Management, Fairtree Capital and analysts at JP Morgan and Credit Suisse at certain points. But these analysts know that, while they made the right call on Steinhoff, they won’t always get it right.
And those who raised objections did so about a general culture and the acquisition structures, not because they had insight into the particular irregularities that have caused the crisis. Their calls were probabilistic rather than definite.
So the active investor market had a plethora of views that led to prices being set in the market. Passive funds have no role to play in this price setting. They are passengers on the bus that is driven by active investment managers. Without active investors, the bus wouldn’t even get out of the garage.
Passive funds suck assets out of actively managed funds. They force investment costs down in the industry because they do not
pay analysts.
Active managers are forced to compete by cutting their costs, which reduces the amount of research that is undertaken. Here is where the penny drops: while we can’t consistently pick winners in advance, a world in which no one tried would have much lower average returns to investors.
We should hold analysts and fund managers accountable and insist they work hard for their money, but we are certainly not going to achieve a healthier investment market if we discourage active investment overall.
If more assets go into passive investment, we are only increasing the probability of more Steinhoffs in future.
The average returns, for passive and active managers, would be weaker.
There is another front that is damaging the average returns investors can expect: governance and the criminal justice system
However, while it is better for all of us that there is active management, it is better for each of us individually to save the costs and ride the passive bus, free-riding on those who do the work. For now, passive investment is not big enough to really harm overall market efficiency, so fill your boots and go passive.
Know, however, that you are going to be exposed to future Steinhoffs and you will have done nothing to reduce that probability.
You certainly should not proclaim that there is a moral case for passive investing – there is only a case based on your personal self-interest.
But there is another front that is damaging the average returns investors can expect: governance and the criminal justice system. SA has experienced a dramatic collapse in commercial-crimes investigation and prosecution. The most embarrassing signal was the failure of the National Prosecuting Authority (NPA) to secure a custodial sentence against J Arthur Brown of Fidentia in 2014.
He literally stole the assets of widows and orphans, but prosecutors struggled to make the case. Jail time was subsequently imposed on appeal, but the incompetence of the NPA’s commercial crimes unit was made transparent.
The unit is now limping along under the leadership of Lawrence Mrwebi, who has been struck off the roll of advocates and embroiled in NPA infighting.
His unit has let countless clear cases of fraud slide, including Brett Kebble’s JCI, Blue Financial Services, African Dawn, Alliance Mining, Pinnacle Point and Tigon, though litigation continues in the last case 17 years after the event. Commercial crimes investigators are ignoring blatant fraud involving Oakbay Resources, the once-JSE-listed corner of the Gupta empire.
This environment, in which white collar criminals can get away with it, ensures more fraud than there would be otherwise. The average returns investors can expect are reduced.
Our anger about Steinhoff is genuine and appropriate, but we should be even angrier about the collapse of the criminal justice system, which will do more overall harm to investors.
Certain political actors have jumped on the Steinhoff case to argue that corruption is a problem in the private sector too. It absolutely is – but the solution lies in getting the institutions of state to do their jobs properly.
Luckily, in Steinhoff’s case, the main problems seem to be in Germany and regulators there are on the case. Former CEO Markus Jooste and others who will be implicated are going to be brought to book.
If only we could confidently say the same of fraud taking place here. The best you can do is diversify your investments and remember that, overall, our capital markets work.
• Theobald is chairman of research house Intellidex and a research associate at the London School of Economics, where he researches problems in financial theory.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.