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Investing in a post-downgrade world

Time to batten down the hatches.

It seems that South Africa has been given a stay of execution by the ratings agency S&P and is likely to receive similar treatment by Fitch.

The good news is tempered by the fact that the next review date is in December and most analysts hold little hope that government will take the necessary steps identified by the ratings agencies as imperative to avoid a downgrade. The consensus is that the government is too busy fighting internal political battles to focus on the country’s long-term future.

Investors who operate in a climate like this need to use the next few months to get their portfolios correctly structured for potentially more turmoil.

Downgrades are not always bad

If you were to study other countries that have been downgraded over the last 20 years, it is evident that their investment markets often improve after a downgrade. This is normal because markets often price in the worst-case scenario and then rebound when it becomes clear that things are not as bad as anticipated. This means that if South Africa does get downgraded, it is likely that our bond market and currency could strengthen in the 12 months after the downgrade.

Our stock market is already very rand hedged with more than 50% of the revenue earned outside of SA. In the event of a major devaluation of the rand, it is likely that the JSE will rise.

If this seems confusing to you, you might take comfort in the fact that everyone else is also confused! Whenever there is major uncertainty in investment markets, you should always resort to proper diversification across cash, bonds, property and shares and also across geographies and currencies.

What to do

If you already have a major offshore allocation e.g. 50% of your investment assets, you probably have little reason to make a change. Over time, you could consider increasing your offshore allocation to 50% of all your assets (investment assets + the value of your residential properties and other ‘dead’ assets) but this is a matter of preference.

If you have limited international exposure, you could consider using future rand strength to start investing offshore. A level of R14.50 to the US$ is a good starting point and if the rand gets to R13.50, you could start investing offshore aggressively. Try not to send out all your money in one batch, rather try to send it out in three batches over a period of months. The currency markets are so volatile and a phased approach might help to limit the impact of this volatility. Just ensure that the banks don’t rip you off with foreign exchange conversion fees.

It is important to note that the international markets are not really offering South Africans a safe haven at the moment.

The US stock market is probably quite expensive, Europe has major problems, the Brits are contemplating economic suicide with Brexit and the Japanese population is ageing so rapidly that I wonder who will be left to actually work in the economy in the years ahead. Finally there is the prospect of Donald Trump, Vladimir Putin and Kim Jong-un causing chaos in the world, which is hardly an enticing prospect for investors.

In summary, sending all your money out of SA in panic at a really weak exchange rate and investing the capital in international markets might double your chances of losses rather than help protect your capital. Rather exercise caution, spread your capital across a range of investments and batten down the hatches.

Stock market volatility and political volatility turmoil is probably going to be with us for a while yet.

Warren Ingram is director of Galileo Capital.

COMMENTS   5

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So what would be a prudent split between local and offshore to build up to?
SA is 1% of global economy, slightly higher in terms of global stock markets. If we discussed for two examples as to a split (my thinking %):
1. Live in SA forever, 50/50 between SA and Global, mainly because of currency swings.
2. Global citizen, 20/80 between SA and Global so you average out global currency.
These are just my thumb sucks, but any thoughts on ratios? Let’s discuss what people have actually done over decades rather than the alarmist rhetoric currently in the comments section of 100% out at any cost.

I think individual investors should consider their total portfolio (Pension Fund, RA and Discretionary investments). Given that Reg 28 forces you to be 75% in SA on PF and RA, you might want to be aggressive on your discretionary portfolio to balance it out (even if you planning to stay in SA forever)

May I suggest that holding physical gold, while not necessarily a good investment in general, will provide saffers with suitable protection against rand currency risk in the short to medium term.

What does “batten down the hatches mean” in the financial context Warren?

“Batten down the hatches” means prepare for difficult times.

End of comments.

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