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What does 12J look like post-COVID

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12J FORECAST POST COVID

Grovest CEO, Jeff Miller, writes about the COVID-19 pandemic and its effect on section 12J.

The Section 12J asset class has gained the trust of a growing number of investors and to date has grown significantly, to over R10 billion in investments as of February 2020.

Enter COVID.

Our environment is not immune to the snowball effect of the pandemic, and it going to change drastically.

It’s no secret the South African and greater world economy is already – and will further be – severely affected. A number of local economists have already predicted up to a 5% negative growth rate in our economy. In turn this will lead to cash flows, liquidity and job losses becoming some of the biggest challenges our economy will face. The immediate implications will realistically take years to overcome, as this snowball came tumbling onto an already weak South African economy.

Section 12J was introduced to the market in 2014 as a SARS-approved tax incentive for investors to keep their funds on-shore and invested into some of the key industries driving economic growth. Investments into Section 12J Funds are known as equity investments. Most Section 12J funds do not have any gearing which in times like this could be extremely advantageous, as they do not have to service interest and capital repayments on debt.

All investments come with a degree of risk. Section 12J investments differ in that every investment into a Section 12J fund automatically receives this uniquely built-in risk buffer of up to 45% as a tax benefit. Effectively, this puts you ahead of the game before you even start. Assuming you are an individual who is paying tax at the marginal rate and has opted to invest R1000 into a Section 12J fund, the asset value can reduce to R550 without incurring a loss on the initial amount invested.

It is estimated that more than R2 billion was raised in February 2020 alone, with most of these funds still to be deployed. Our learnings over the years show us that having ‘dry powder’ (i.e. cash reserves) is the ideal place to be – to take advantage of opportunities as they arrive – especially during times of crisis.

Jeff Miller, Co-Founder and CEO of Grovest (who launched the first Section 12J and today administer the largest number of 12J funds in the market) is of the opinion that over the next few months the Section 12J industry will commit to injecting additional capital into the economy in an aim to support companies with cash flow constraints and assist with job retention, thereby assisting the Government’s precarious position to support the economy. Miller is confident that Government will recognise this when they consider extending the June 2021 Sunset Clause (when the 12J legislation is revisited by Treasury).

Grovest manages a number of funds from different sectors of the economy, and Miller believes that some Section 12J funds will perform better than others during this period, depending on the fund mandate.

Here is his view on the different funds within different sectors, and how Grovest projects their performance during this difficult time.

Hospitality Funds 

Due to the nature of the business, hospitality investments as a rule have been greatly effected by the COVID-19 outbreak and the lockdown. The local and international travel bans implemented have cut the travel industry at the knees. In turn, performance of the hospitality funds in the short term will be adversely effected, and it is unfortunately due these circumstances unlikely that any dividends will be paid to investors. Important to note that Cape Town hotels may be less effected as business in this region is seasonal and historically during the winter months, most Cape Town hotels make losses. But if we take a longer term view, hospitality will also be incredibly robust in bouncing back from this crisis.

For now, there are a few hospitality funds which offer a minimum guaranteed yield to investors, notwithstanding the trading results of the hotel operations. The Pepperclub Invest VCC is one such fund. Investors are guaranteed a minimum of 6.5% operating yield, escalating at 8% p.a for 5 years making this an incredibly attractive hospitality investment within the Section 12J sector.

Energy Funds

Section 12J energy funds enter into long term Power Purchase Agreements (“PPA’s”) for between 10 and 20 years, meaning that overall returns should not be negatively effected by COVID-19. However, funds focusing on domestic energy installations, such as gated communities and section title developments, may in fact perform better over this period as more people are homebound and utilising more energy. Industrial factories that are not considered essential goods suppliers will be using very little energy over this period as there is less of a demand from consumers due to Government regulations. Shopping centers continue to consume energy as essential supermarkets and pharmacies continue to operate, using energy for air conditioning, fridges and in most cases lighting.

Asset Rental Funds 

The industry to which the assets are rented out to, determines the risk of the  fund. Cash flows of the counter-party (who the assets are rented out to) is extremely important. Some funds have given customers a 3 month payment reprieve. Assuming that we get back to a new normal within the next few months, it is unlikely that divided payments to investors will be materially affected.

Fund of Funds 

The portfolio of funds model, which MeTTa Capital manages, is perfectly positioned for unpredictable times like these. MeTTa Capital invests into a portfolio of leading Section 12J funds, offering investors a diversified, moderate risk investment. The diversified portfolio is constructed to include diversified industries with different investment mandates. The adage of don’t put all your apples in one basket is very relevant in these times.

When comparing the performance of a Section 12J investment to listed shares on the JSE, it is glaringly obvious that the Section 12J asset class is holding its own, as it continues to hold value and pay dividends, has a built in risk buffer that many other investments cannot boast of in these tumultuous times, not to mention the major role that these Section 12J funds will be playing in creating much needed liquidity in the South African economy as we re-emerge to a new normal.

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