First Strut investors stand to lose R800m

However, the asset allocation restrictions may have limited retirement fund members’ losses in what is being called South Africa’s “Enron”. Bruce Cameron reports The losses for investors, mainly retirement fund members, in the multi-billion-rand collapse of South Africa’s biggest unlisted company, First Strut (trading as First Tech Group) could total more than R800 million – but they could be fractional for each individual investor.

The collapse of First Strut is being compared to the multi-billiondollar bankruptcy in 2001 of United States company Enron that left retirement fund members destitute as it sank in a sea of fraud.

Many employees had all of their retirement savings invested in Enron. In South Africa, a unit trust fund or a retirement fund may invest a maximum of 10 percent in the bonds of a single company, such as First Strut.

Asset managers that bought First Strut bonds on behalf of retirement funds and unit trust funds were more prudent, so the holdings of any one fund member or investor are fractional. Investec Asset Management (IAM), for example, allocated 2.9 percent of seven targeted portfolios to First Strut bonds.

Nevertheless, the First Strut losses are significant and raise important questions about why such massive fraud went undetected by regulators, banks, fund managers, credit rating agencies, auditors and asset management consultants for almost 20 years.

The losses are a result of First Strut defaulting on the R925 million that it borrowed on the corporate bond market, most of which will not be recovered. The asset management companies that invested in the First Strut bonds are concerned about loans that the banks did not disclose when the bond issue was arranged. These lenders could now have first claim on any of First Strut’s assets, leaving the bonds with zero value.

There have been concerns for some time about the formal corporate bond market, where large companies borrow billions of rands to fund their operations. Borrowers in this market are subject to the listing requirements of the JSE, but large lenders (buyers of the bonds), such as asset management companies, regard these requirements as insufficiently comprehensive (see “Asisa steps up bond market investigation”, below).

FRAUD UPON FRAUD

The asset management companies that admit to incurring losses as a result of the First Strut default are emphasising the negligible losses to individual investors in an attempt to explain how what appears to have been 20 years of fraud upon fraud went undetected by themselves, Global Credit Ratings, the auditors and the banks that lent money to First Strut for many years.

The asset managers that are known to have been exposed to the failed corporate bonds (borrowings by First Strut) are IAM, Sanlam, Prudential, Stanlib, Momentum and Fairtree Capital.

Many more asset managers could have been involved, because most South African asset managers applied unsuccessfully for an allocation of the main First Strut bond issues.

IAM has the biggest exposure, with R435 million in institutional port-folios (portfolios used mainly for retirement fund investments).

John McNab, IAM’s co-chief investment officer, says that when Investec decides whether or not to invest in bonds, it takes account of the potential for a default, which could result from market conditions, operational problems with the issuer of the debt and, less frequently, fraud.

The losses for individual retirement fund members will be fractional compared with the 12.5 percent that Investec deducted from the savings of members of industrial retirement funds when it took control of imploding financial services company Fedsure in 2000; or the R175 million that Sanlam paid to make good for its role in the stripping of surpluses of retirement funds in the 1990s.

Kobus Möller, Sanlam’s group financial director, confirmed that Sanlam “invested some R236 million in the First Strut bond, the major part of which is being held in its own corporate debt portfolio”.

Möller would not say whether individual or institutional investors have been exposed to the bonds and, if so, how much they stand to lose.

Bradley Anthony, a director of Fairtree Capital, says his company has an exposure of R131 million to the First Strut bonds.

John Kinsley, chief executive of Prudential, says his company has an exposure of R51 million across 19 of its portfolios.

Lerato Mametse, MMI Holdings’ external communications manager, says the company’s exposure to First Strut was mainly via the Momentum Income Plus Fund. This resulted in the unit price of the fund dropping by almost two percent over the week of July 8, when First Strut defaulted.

Stanlib refused to provide any details of its exposure to the default, saying: “We appreciate the opportunity to respond. We are unable to comment on this matter, due to client confidentiality.”

McNab says the First Strut bond issues had an investment- grade rating of BBB, passed due diligence tests by Investec’s credit committee and were audited by the