By Malcolm Charles & Peter Kent, Portfolio Managers
Investors have had a lot to digest on the domestic front – the firing of finance ministers Nhlanhla Nene and Pravin Gordhan, rating downgrades, state capture allegations, calls for President Jacob Zuma to step down and the approaching ANC leadership race – to name a few. Emotions are running high in the country, and the uncertain environment has left many SA investors sitting on the side lines in cash. The political situation may leave South Africans feeling angry or fearful, but we believe investors should be careful not to let emotions steer their investment decisions.
In a world gone crazy…we are not alone
Having a controversial president and an unpredictable political situation is not unique to South Africa. There is political turmoil across the world. Russia’s involvement in the US elections continues to dog President Trump’s presidency. The US leader’s outbursts have not only fuelled divisions in his own country but also internationally. Turkey is in a permanent state of emergency under President Erdogan and North Korea’s missile programme is causing global anxiety. Brexit has sparked massive uncertainty among consumers and businesses in the UK, while anti-immigration sentiment in Europe is casting a shadow over the continent. Clearly, many countries across the world face challenges on the political front. Understanding that South Africa is not alone, is key from an investment perspective.
Economics – the common thread
We believe economics is the common thread underlying the political angst across the globe. In response to the global financial crisis ten years ago, central banks poured money into the financial system and asset prices have skyrocketed since then. The wealth of many asset owners has grown substantially in the ensuing ten years, but the average worker’s standard of living has gone backwards. Of course, economic concerns manifest differently in each country. But, in our view, realising that economics lies at the heart of the political turmoil in South Africa and across the globe, should help local investors to assess opportunities more objectively and help avoid emotional decision-making. After all, foreign investors do not view South Africa through an emotional lens. They do not look at our country in isolation but carefully assess how we stack up against other emerging markets (EMs) when they seek investment opportunities.
So how do we compare to our EM peers?
Even though we’ve had a cabinet reshuffle and we face a tough political and economic environment, from a valuation perspective South Africa looks reasonable compared to its EM peers. SA government bonds with a maturity of ten years currently offer an attractive inflation-beating yield of 8.5%, with the inflation rate heading towards 4%. While many South African investors have shunned SA bonds, foreign investors have piled into our market to the tune of R100 billion (six months to end June). This year, bonds (All Bond Index) have already gained around 7%, while the rand has appreciated some 6% against the US dollar. Foreign investors sponsoring our market also helped returns last year. Despite the negative news flow and political uncertainty, South African bonds returned 16% over 2016, while the rand outperformed the US dollar by 13%. Local investors who chose fixed deposits missed out on this opportunity.
Looking beyond particular events
South Africans were fixated on the cabinet reshuffle this year. Wide-spread panic meant that many local investors couldn’t see beyond the political drama, unlike foreign investors who supported our bond market due to the favourable global backdrop. SA market participants have now become fixated on the potential outcome of the ANC’s elective conference in December. But we are trying to look beyond December and consider the fundamentals of South Africa in the context of a wider EM and global environment. Weak economic activity and low inflation should drive the SA repo rate lower. We expect interest rates to reach either 6.25% or 6%. Lower rates are normally very supportive of the bond market. Of course, we take cognisance of the political situation, and we do have the option of buying protection for our portfolios when political risks are high.
So how are we positioning the Investec Diversified Income Fund?
We have a high conviction position in investment-grade credit. A year ago, we forecast that South Africa would enter into a recession. But it was only in the middle of last year that we felt that credit spreads were priced for a recession. We have invested in good quality businesses such as Santam, FirstRand, Growthpoint and Mercedes-Benz, which are giving us an attractive yield of close to cash plus 2%.
Their robust balance sheets should show resilience in the face of economic and political headwinds. We have a small allocation to government bonds and we favour those instruments with a maturity of less than ten years. These bonds are sensitive to interest rate moves and should benefit if rates decline more. Low growth means tax revenues could disappoint. We are concerned about the fiscus so we have been avoiding longer-dated bonds. Our view on the rand is neutral. Over the last 18 months, China and the commodity upswing has been driving the local currency. China is doing well and its economy is pretty much at cruising altitude. We are maintaining a small offshore exposure to help protect the portfolio from political headwinds, should conditions deteriorate.
The SA political and economic landscape will no doubt continue to be very challenging. And while political developments may leave many South Africans fuming, we urge investors not to get angry with their investments – decisions on their savings require a clear head.
All information provided is product related, and is not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Collective investment scheme funds are generally medium to long term investments and the manager, Investec Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing, up to 10% of fund net asset value to bridge insufficient liquidity, and scrip lending. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant Total Expense Ratio (TER). A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The ratio does not include transaction costs. The current TER cannot be regarded as an indication of the future TERs. Additional information on the funds may be obtained, free of charge, at www.investecassetmanagement.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. Investec Asset Management (Pty) Ltd (“Investec”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA). The offshore funds are sub-funds in the Investec Global Strategy Fund, 49 Avenue J.F. Kennedy, L-1855 Luxembourg, Grand Duchy of Luxembourg, and is approved under the Collective Investment Schemes Control Act. Issued by Investec Asset Management, August 2017.