Investors in South Africa probably feel that they already have plenty to worry about. Low market returns, a struggling economy and ongoing political uncertainty make this a tricky environment.
However, taking a long-term view on investing means having a perspective on much more than just what is apparent right now. Speaking at Meet the Managers in Cape Town on Thursday, Gavin Wood, chief investment officer at Kagiso Asset Management, noted that there are six significant issues that investors can’t afford to ignore.
1. The growth of populism
“Populist extremes are replacing the rational centre in politics for the first time since World War II,” Wood argued. “Brexit is an example of a populist vote, voting against their own self-interest.”
A lot of this has to do with growing inequality and distrust in the public institutions that don’t appear to be serving everybody. Even scientific knowledge is being questioned, such as that in the anti-vaccination movement.
“This makes for potentially irrational outcomes,” said Wood. “You can’t think about things going into the future in a logical way if voters are going to do something that is potentially self-harming, or irrational, and if people are going to believe certain things in the absence of science. That is quite a hard environment in which to make investments.”
2. Monetary policy impacting the laws of finance
The extreme monetary policy interventions the world has seen since the global financial crisis has created an investment environment never seen before, and is arguably unsustainable. This is problematic when a majority of investment professionals don’t have experience beyond the last 10 years.
“To not have a long-term perspective, and to think that this is normal – where inflation is non-existent, and where interest rates can be zero or negative for a long time – breeds complacency and a lack of understanding of what finance is all about,” said Wood. “This has introduced moral hazard. As soon as markets have a bit of a wobble, central banks put up their hands and say we’ll bail you out. So you just take on more risk.”
Low interest rates have also led to countries and companies taking on more debt. That isn’t problematic now, but if interest rates rise, that debt becomes a potentially significant problem.
3. The return of inflation
There is very low expectation that inflation will come back into the system, but Wood sees a few things that could fuel it.
“Populism is arguably inflationary,” he pointed out. “Being anti-immigration means that you limit the low-cost labour that can come into your economy, so you bid up wages. Protectionism and tariffs are also inflationary because they lead to imported goods costing more.”
Central banks have also indicated that they would be prepared to let economies run hot rather than raise interest rates too much.
“If this does change it has huge implications,” Wood said.
4. Is globalisation reversing?
“Since World War II we have had a level of stability and growth that is abnormal in world history,” Wood argued. “The world came together – we have had one, largely benevolent, superpower that has been pro global co-operation, and that has seen a huge rise in prosperity in the world.”
This is particularly true in many poorer countries, most notably in Asia. This has, ironically, led to the rise of China, which is now potentially a competing superpower. Populist sentiment is also turning against multilateralism.
“The benefits of global co-operation are immense – trade, the free flow of ideas, capital and people, and huge increases in living standards,” Wood pointed out. “But if globalisation does go into reverse, that would be very negative for global growth prospects over the longer term. When valuing equities, if base load growth is lower that is quite important.”
5. Public governance in South Africa
The current government is a huge improvement over that which preceded it most recently, but Wood pointed out that it has inherited material structural challenges. The most significant of those are government’s climbing debt burden and rising unemployment, both of which are negative for the budget – the former because it requires ever-growing debt-servicing costs, and the latter because of the need to provide social grants. This doesn’t leave much for spending on improving structural growth.
“My view is that the better government will be enduring, even though there is a fight back,” Wood said. “It will also be effective, but improvements will likely take longer and will be fraught with risk along the way. We are therefore circumspect about building portfolios that expect a South African economic improvement.”
6. Corporate governance in South Africa
The state of management in South African businesses and the role of boards has become a major focus for investors. Wood, however, said he believes the market has probably become too gun-shy on this issue.
“There have been some huge corporate disasters, but there was only one Steinhoff,” he said. “It’s an error in judgement to believe that every share that goes down is the next Steinhoff. There have been lots of capital drawdowns, but many of those were because share prices went too high in the first place.”
Instead of being a systemic problem, he said this is an opportunity.
“Our sense is that corporate governance is very strong in South Africa and it’s going to get better,” Wood said. “The JSE has high standards, and auditing firms are going to improve. Asset managers, having been bruised, are now going to the other extreme and creating opportunities as prices go very low.”