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How bad is the foreign selling of SA assets?

Putting it in context.

Over the last week a fair deal of concern has been raised about foreign selling of South African bonds. To the end of July, foreigners had sold more local bonds than they had done over the first seven months of any year since 1998 according to Bloomberg.

Read: Foreigners sell rand assets at record pace as Eskom woes mount

These outflows began in May and accelerated through June and July. As the graph below shows, there has now been a noticeable outflow from South African assets this year.

Source: Bloomberg, JSE

It is, however, important to put this in context. Foreigners have been net buyers of South African bonds for almost a decade. According to figures from National Treasury, foreigners owned only around 11% of South Africa’s total bond issuance in 2011. By the first quarter of 2018, this had grown to a peak of 43%.

The outflows over the last few months have only reduced this to around 37%.

“When you talk about billions of rands, it is large amounts of money, but it’s fractions of South Africa’s total debt,” explains Albert Botha, the head of fixed income portfolio management at Ashburton Investments. “It’s not positive, but it’s not as if foreign holdings have gone from 40% to 20%, which would be catastrophic.

“These are concerning trends, and it is clearly affecting our bond pricing and our currency, but it’s not as much of a crisis as some people would like us to believe.”

In fact, as Ian Scott, head of fixed income at Momentum Investments, points out, there is reason for the market to see this reduction in foreign holdings as “not a bad thing”.

“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.”

Global context

It’s also important to bear in mind that South Africa isn’t the only country that is experiencing foreign selling of its bonds. Investors are reducing their exposure to emerging market assets in general as concerns have grown around the trade friction between the US and China, and global growth in general.

“South African bonds don’t live in isolation,” Scott points out. “Globally there is a move out of risky assets into more safe haven assets.”

This is most obviously reflected in the price of gold climbing from $1 200 per ounce at the end of April, to over $1 500 today. That is a 25% jump.

This global risk aversion doesn’t, however, explain all of the foreign selling. Outflows from South Africa have been more exaggerated than those from some of the country’s emerging market peers as concerns have grown about South Africa’s fiscal position, sustained low growth in the local economy and the threat of a downgrade from Moody’s.

“We have probably been hit harder than we would have been if the news had been in isolation,” says Botha. “It’s not just the general global malaise. There are some South African-specific factors.”

There are still buyers

What’s also important to consider is that there are still plenty of buyers for local bonds. Even though there was a larger than normal bond auction this week on top of continued foreign selling, local buyers have been willing to step in.

“The real yields on South African bonds are still attractive given the risks, particularly when compared to other asset classes,” Scott argues. “So more and more local investors have been prepared to get in.”

The real yield refers to the return that investors are earning from bonds above inflation. Currently, this is between 4% and 4.5%.

Attractive

This is attractive in an otherwise low return environment, and this is reflected in the bond holdings of local multi-asset funds. According to the Alexander Forbes Manager Watch survey, the average allocation to South African bonds in the large balanced funds it covers has grown from 14.68% at the end of 2013 to 19.19% by the end of 2018.

“If you also look at where our current real yields sit compared to many of our peers, its also seems that South African bonds look attractive against many of our peers just on a standalone basis,” Botha points out.

As the graph below indicates, the real yield available in South Africa is higher than any of these other emerging markets. The country does however carry the twin risks of its high budget and current account deficits.

Source: Bloomberg, Ashburton Investments

South African bonds are therefore now looking fairly cheap, and while they could still get cheaper, this does create a margin of safety for investors. Particularly because a lot of bad news is already priced in, including the chance of a downgrade.

“Should the global market turn more positive, the bond market will benefit, although we do seem to be constrained by the local economic situation,” says Botha. “I think that South African bonds do offer value, but barring some significant institutional and structural progress, I don’t foresee us having a significant bond rally outside of changing global sentiment.”

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What happens to investment houses and fund managers when SA is completely sub-investment grade?

How much of their investment capital will be withdrawn?

I think it’s more or less self-explanatory that you should not be holding shares in investment houses or fund managers right now.

Thank you for this informative article Patric. The Aussie dollar is also going weaker against the US dollar. The rand is not alone. The currency war between the US and China has a fallout on our situation. We are the “grass” that gets trampled “When the elephants fight”.

I only noticed last week how badly the Aussie has held up – lost over 40% to the USD over 5 years. It has only gained 20c against the Rand over the past 5 years. If you emigrated over the last 5 years it would have been better to leave your cash in SA in fixed income than in Aussie cash and almost the same in Aussie equities!

You can hear the sigh of relief from the directors of ALCAN who rejected going to Couega for an Aluminium Smelter.

SA used to generate electricity well at prices below the international average and now the SOE is bankrupt (without continual massive state bailouts).

The foreign investors care little about local real yields. That’s only relevant to SA investors.

Foreign entities buy bonds hoping to lock in yield and capital appreciation greater than they can get in developed markets. When the currency starts to wipe out any gains, they run for the exits. Often they hedge rand risk though if they can.

African countries have wonderful high yields. Foreigners aren’t buying the debt because they can’t hedge the currency risks.

The quickest way to get rid of foreign investors is via devaluing of currency. The last 2 weeks has been a good example of that.

Don’t follow you; which currency was devalued in the last two weeks? Not the ZAR as it merely lost ground, it wasn’t “devalued.” Maybe you mean Zim dollar?

The foreigners will be back…8% yeild vs 0% ?…watch them come back

Agree. Until there’s a bond default…after SA ran out of taxpayer’s kind donations, and retirement funds left to dry up from prescribed assets, to guarantee the bonds.

R 100 Billion left to leave when S A goes to junk. Get ready !! Interest rates will rise and those with debt MUST stop accumulating and start paying! Dr. Debt

No reason to invest here-look at today alone-MTN -HEPS down, Standard bank less than inflation growth from a premium bank -City Lodge down inflation plus nearly 20% -The economy is starting to collapse!!

Graph from Ashburton is very informative, even if it is a bit complicated.

Enjoyed the graph from Ashburton albeit quite complicated – clearly some rocket scientists work here

Most informative and interesting article. Thanks Patrick

I seem to have a serious desktop-PC problem & may need IT advice:

Every time I want to happily transfer funds to SARS, or want to lovingly make a charity donation to any state SOE, the installed malware causes the damn funds to be converted into USD and ends up in a US stock broking account in my name. How painfully frustrating!

Now it’s stuck there in the US 🙁 And its been painfully gaining against the ZAR….

Sigh, I will try again shortly. Maybe I should keep this irritating bug on my PC?

Damn, there it happens again!! ZAR to US$ 🙁

In fact, as Ian Scott, head of fixed income at Momentum Investments, points out, there is reason for the market to see this reduction in foreign holdings as “not a bad thing”.

“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.”

I do not understand. So it is somehow better that foreigners sell out of SA before the downgrade than after the downgrade? Surely selling is selling regardless of when it takes place?

It should also tell you something that foreigners held 11% in 2011 and 43% now of our bonds – that means that foreigners picked up most of the new issuance during that period, without foreigners picking up our escalating need for finance who will?

Also I think a move from 43% to 36% over “a few months” is actually quite pronounced – that is nearly a 20% absolute reduction.

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