Over the past few years South African asset managers have preferred holding international equities to investing in the local stock market. Their view has been that the potential returns offshore have been much higher.
They have been proven correct too. Over the five years to the end of March 2019 the MSCI World Index was up 11.72% per annum in rand terms, while the FTSE/JSE Top 40 had grown only 6.44% per annum.
However, this view is starting to shift. While many fund managers still believe that there are better opportunities offshore, the perception of the local stock market is improving.
The Old Mutual MacroSolutions boutique, which recently published its annual Long-Term Perspectives, now expects that over the next five years, the potential returns from the JSE are higher than those investors can expect offshore.
Expected long-term real returns (after inflation)
While a 5.5% real return from the JSE is still below the long-term average of 7%, this is clearly an improving outlook.
“This is the first time since 2014 that we feel the forward-looking returns from South African equity are higher than they are for global equity,” says Zain Wilson, portfolio manager at MacroSolutions.
There are broadly two reasons for this.
“On the one hand the US has had 10 really good years,” Wilson explains. “It has benefitted from easy monetary policy after the financial crisis took all of the credit out of the system, and you’ve had fiscal easing for the last three years.”
MacroSolutions agrees with IMF forecasts that the US will move from this period of strong growth to incrementally lower growth over the next five years.
“At the same time, South Africa has had five years of pain,” Wilson argues. “Part of that pain has been driven by a weak Chinese environment and weak global trade on which we are reliant, and there has been a lot of self-inflicted pain.”
However, this pattern is changing.
“The US is slowing down because they don’t have all the tailwinds that have helped to boost the economy and the market over the last 10 years,” Wilson notes. “And there is also incremental positive change in South Africa, starting with better fiscal management and improved governance.”
These changes in South Africa are not going to realise massive improvements in economic performance immediately, but they will at least start to reverse the downward trend. This will also be aided in Wilson’s view by an inevitable shift in investment flows.
Over the last 10 years external investment by domestic companies has been exceptionally high. High profile examples include Woolworths buying David Jones in Australia, Brait’s purchase of New Look in the UK, and a number of property companies making acquisitions in Eastern Europe. At the same time, foreign direct investment (FDI) into South Africa has been extremely low.
The appetite and capacity for local companies to invest offshore has however dissipated. Wilson believes that just removing those outflows will remove a big headwind.
At the same time, an improved local environment will become more attractive for foreign investors.
“If you get delivery on policy certainty, resolve the mining charter debate, the wage debate, and land expropriation, that sets the foundation for stronger FDI going forward,” Wilson argues. “That will make a big difference.”
Improvement off a low base
This will be accompanied by a shift in business and consumer confidence.
“Confidence is so low that if you just start building that again, the impact will be significant,” says Graham Tucker, portfolio manager at MacroSolutions. “We have clearly done damage to ourselves. We have scored own goals. But if we can create more certainty and put better policies in place, confidence will come back.”
These twin improvements will change the outlook for the local economy.
“As confidence improves and FDI outflows stop, the base is very low for a cyclical recovery,” says Wilson.
“The growth recovery will take time, but if we can see stabilisation in the cost of capital and a steady rand as governance improves, then we expect the improvement to start there.”
That, Tucker believes, will translate into growth for local equities, particularly since many companies exposed to the local economy are currently trading at low valuations. Even a small improvement in the overall environment could translate into much more positive sentiment.
“Our view is that South Africa will improve,” Tucker notes. “That means we are not buying the biggest weights in the index, but accessing mid and small cap companies that are currently small components of the index, but are offering the most value in our view.”
Investors should not, however, expect to see results immediately. This is a long-term story.
“We see the actions that the government is taking continuing slowly but surely, and that will build confidence,” says Tucker. “It’s coming off such a low starting point that any improvement will see a material rerating of South African assets. But a lot of the action that needs to be taken will take time. It’s not going to happen overnight. It requires patience.”