Over the last few months a narrative has emerged that foreign investors are deserting South Africa’s bond market. Some commentators even held this up as evidence that the country is becoming uninvestable.
However, a recent note from RMB Global Markets Research points out that the data on which these analyses are based has some shortcomings. In fact, more reliable data shows that foreigners still have a healthy appetite for South African bonds, and have actually been net buyers of R55.4 billion worth this year.
The investor perception about foreign selling of bonds has mostly come from Bloomberg’s daily reports of net purchases by foreigners, which is sourced from the JSE. This specifically looks at daily trades, but for a number of reasons this data does not provide a complete picture.
“Firstly, the daily data provided by the JSE is adjusted and revised before it is re-released as weekly, monthly and annual data,” explains Kim Silberman, fixed income and currency economist at RMB.
The chart below illustrates how the JSE’s aggregated daily trade data, which is what is reported most often, can differ quite significantly from its own monthly data. For instance, the monthly data shows significantly less foreign selling over June, July and August than suggested by the daily data.
The first shortcoming in the JSE’s daily data is that it captures all the trades placed on the exchange, but not all of those trades are necessarily executed. It also does not account for certain derivative trades or parts of such trades. Secondly, JSE data is also reliant on financial institutions providing information about where market participants are domiciled.
For these reasons, Silberman argues that the more accurate data is that which is provided by Strate to National Treasury, which is based on a completely different exercise.
“They are not looking at trades, but at the holdings data,” she explains. “They aren’t trying to aggregate and decipher daily trades to get to a net trading position at the end of a month. The data tells you the value of SA bonds held by foreigners at the end of each month and you can then compare that to the month before. That is a much more accurate reflection of flows.”
Differences also arise because the JSE would not capture redemptions (when a bond holding is paid out because it falls due).
“At that point the government has to pay the bond holder back,” says Silberman. “There would be a reduction in foreign holdings because you’ve had to pay back the bond, but that is not going to be captured in JSE statistics.”
Looking at the change in foreign holdings on this basis shows that international investors have actually been net buyers of South African bonds this year. The chart below contrasts this number with those provided by the JSE.
“The data coming from National Treasury is a much more accurate reflection of changes in foreign bond ownership, and the picture it is giving is very different,” Silberman points out.
“While the JSE data is useful, as it is the only source provided daily and in time series format, it is important to understand that it’s not clean. It still has to be cleaned for you to get a better picture of the flows.”
Unfortunately many commentators have been using the JSE data as though it is already clean, and that, Silberman believes, is a mistake.
“It’s important because it impacts sentiment, and it’s important because the National Treasury data shows that we are exposed to the impact of a downgrade,” she says.
The Moody’s factor
Analysts have been pointing out that some foreign selling of South African bonds actually lowers the likely market impact of a credit downgrade by Moody’s, because a number of international investors would have ‘pre-sold’ on the expectation that this would happen. As Ian Scott, head of fixed income at Momentum Investments, points out, the more local bonds foreigners hold, the more might have to be sold in the event of a downgrade.
“In the face of a possible ratings downgrade, you don’t want to have a massive foreign overhang that will hit your bond market when everyone wants to get out,” he notes. “Not that I’m convinced that all the foreigners will leave if there is a downgrade, since our real yields are high, but there will be a knee-jerk reaction.”
The crucial consideration is that a downgrade by Moody’s would mean that South Africa falls out of the FTSE World Government Bond Index (WGBI). Funds tracking that index or who can only hold investment-grade bonds would then be forced sellers.
Silberman however points out that there are good reasons why these asset managers would find it difficult to sell out of their South African bond positions before that happens.
“Our view is that foreign bond holders will prefer to hedge their bets via the currency ahead of the MTBPS [medium-term budget policy statement] in October and Moody’s country review on November 1, since a downgrade is not the consensus expectation,” says Silberman.
“As South Africa’s bonds are the highest yielding in the WGBI, it becomes very expensive for those funds tracking the index to be short SA bonds.”