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The outlook for SA fixed income: With all the risks, is there value?

‘From an investment perspective the bond market, while it’s not the best it has been over the last year, is certainly better than it’s been over the past decade’: Peter Kent – co-head of SA & Africa Fixed Income, Ninety One.

FIFI PETERS: While the JSE didn’t do much, we did have a bit of activity in our rand today, with the currency falling nicely below R15/dollar again; just slightly below, however. Usually when we have that kind of movement with our currency, it tends to reflect some activity in our bond market, which is where our government goes and raises money, as it were. It’s also where foreign investors get to rate us, get to rate how costly or risky they think we are to a lender. We see what that rating is (in the bond market) or the price that foreigners charge to lend us money.

In terms of a conversation around what is happening in our fixed-income market or our bond market, we have Peter Kent, co-head of SA & Africa Fixed Income at Ninety One, joining the show. Peter, thanks so much for your time. I understand that Ninety One held a rather interesting webinar about our fixed-income market and whether we are headed south, or whether we’re finding our true north as a country, just given the recent changes that have happened. Where do you lie here? What’s your answer?

PETER KENT: Hi, Fifi, good evening and thanks for having me. We had a webinar today with Kuben Naidoo, the deputy governor of the Reserve Bank, discussing this issue. The background to the webinar was I was asked by our London colleagues to write a piece for foreign investors about what’s happening in South Africa. We’ve had about a decade of action in South Africa over the past 18 months, and they wanted to figure it out.

Look, I think over the last 18 months we’ve oscillated. Covid, everyone would understand, was a pretty terrible time. Our bond market was pretty uninvestable; the Reserve Bank had to intervene. In June last year we had a special appropriation budget where the finance minister then had to spend a bunch of money on Covid.

I would say that was probably our worst case over the past 18 months from a bond-market perspective. Debt-to-GDP was forecast to be at very high levels. If you recall, the finance minister then had two scenarios, sort of active and passive, the markets priced somewhere in between.

But I actually think the good news started to happen towards October/November. The commodities that we export the world wanted in a post-Covid world, so we managed to generate export revenues. Those sort of paid salaries with profits in mining companies. That found the way into the tax coffers.

For the first time in a decade the South African case for the bond market was actually quite positive. That lasted till about June – quite a short little window. Things were looking fantastic. Reform momentum was gaining. The Treasury was quite disciplined with this commodity windfall, so things were looking fantastic.

And then things changed with the riots. The riots put pressure on our fiscus; there are going to be welfare payments there. Security is a concern to the average foreign investor as well.

People are generally a little concerned about whether our cabinet is distracted on keeping peace and security, as opposed to the necessary reforms.

So where do we stand? Long answer – if you take June as the worst case last year and June as the sort of best case this year, I would say we’re off the best case. We’re about 20% to 25% off the best case. But, from an investment perspective [the] bond market, while it’s not the best it’s been over the last year, is certainly better than it’s been over the last decade.

FIFI PETERS: I got a feeling of nausea there, as you took us through the journey of the up and down moves that we have seen in the bond market in the past year. But, from an investment point of view, when last I checked, our 10-year benchmark bond is trading at yields around 9%. So it’s a 9% return that you’re getting, as opposed to what you’re seeing in more developed markets. Let’s just use the US – and there it’s around 1.3% or so.

From an investment perspective, and if you’re looking to make money out of the difference between South Africa and a developed market like the US, would you be advising people looking to make that trade to go ahead?

PETER KENT: It’s a great question, and I think what has been largely the investment case for South African bonds over the last decade is we’ve been too cheap to ignore. It hasn’t been a particularly positive one, it’s just that we’ve been dirt cheap, especially with the low yields in the developed world. That is what attracts foreign investors to our market.

But for that brief six-month period we were more than too cheap. We actually had a really good structural case. I think that structural case is still there. There’ve been some key cabinet appointments. There are some things to watch. I think the other thing, as a South African investor, when you think about 9% yields in our 10-year government bond, that looks pretty tasty versus cash, which is in the threes. And it also looks pretty tasty versus inflation, which is in the fours.

So we’re definitely very cheap as a South African investor and a global investor.

FIFI PETERS: Peter, I know that the bond market also gives a lot of signals about how investors, both local and foreign, are thinking about the economy and its prospects and its ability to grow and its ability to even make do or pay down its debt. You and I are having this conversation in [a situation where] South Africa’s debt is rated below investment grade; it’s junk.

So, as you look at the bond market presently, what is it saying about how South Africa is likely to come out of this Covid-19-induced slump and how long is it likely to take?

PETER KENT: That’s a great question, a tough question. I’ll answer it the following way. I think the bond market sent a very clear signal in 2015 post Nenegate. Our bond market has never recovered [to] the levels before that. That was a watershed moment where our bond markets got a real sense that our fiscus and politics were heading in the wrong direction. We’ve never really recovered from that.

We are now above those levels, so I would say the best-case scenario would be for our bond markets to sort of go back to those levels. I would say we’re five years, 10 years away from those levels.

But the bond market, interestingly, and the currency – I think one thing you can be buoyed by is our market has completely outperformed our emerging-market peers over the past six months because of this windfall.

We do produce commodities that the world wants. The Treasury has been very disciplined with those tax revenues, has reduced issues. As a result of that our bond market and currency market have constantly outperformed our emerging market peers.

So the signal the market has been sending over the last six to eight months is quite positive.

If the new finance minister keeps that discipline, is reasonable with the welfare expenditure, and if the new appointments in the presidency keep that reform zeal, we can perform a lot better. I would say that the signal is not as good as it was a few months ago, but it’s still a reasonable signal, especially in relation to our peers.

FIFI PETERS: I wanted to ask you something about the corporate bond market, but you’ve just said something that’s taken me off when you said that it’s not as good as it was a couple of months ago. So I look at what has happened in that period of time.

We do have a new finance minister, there have been riots, but we have come [back] from those riots. And we’re also presently in a situation where there’s a bit of concern around the pace of vaccinations, how that’s going, and whether we’ll get into another lockdown or be able to avoid it. So, which is it? Perhaps let me be specific. What is our bond market thinking about our new finance minister?

PETER KENT: The bond market got a little bit of a scare with the new finance minister – not because of the candidate. It was just the timing. The new finance minister has his investor-friendly credentials. So the market settled down quite quickly. I just think the timing was interesting because we’d just had the riots and I don’t think anyone was anticipating the finance minister changing at that point. We were anticipating the focus being on health and security; the finance minister wasn’t really in play. So that’s what caught the market by surprise.

It also happened at a time where we’d just negotiated a wage bill for our public-sector workers. There were some key questions post the riots on welfare cost, so it wasn’t really a time where you wanted to force changes. But I think that’s something we’re watching very closely – how the new finance minister deals with this expenditure pressure and, importantly, this windfall that you’ve received in revenues. Exactly that. It’s a windfall, it’s temporary, it’s due to commodity prices and they are not going to stay at these levels forever. So if the finance minister realises that, as I’m sure he does, and is disciplined with that, that would be a very, very positive signal.

On the Covid issue, I saw a great chart yesterday – and I know there’s been a lot of bad sort of press between South Africa and Australia when it comes to rugby, vaccination and herd immunity. Immunity in the population is a function of vaccination and how many people have had the virus. If you look at the estimates of South Africa versus Australia, for example, our population is estimated to be 60% to 70% immune, a combination of vaccination and people having (had Covid). Australia is at less than half that.

So while our vaccination programme is only really ramping up now, and has taken time to sort of get to these points, there does seem to be (some) immunity in our population because we’ve had a different Covid strategy. As a result we’re actually faring better than countries that have gone to the zero-Covid policy in terms of the sense in immunising the population.

FIFI PETERS: Interesting, a very interesting chart there. Just a last one Peter. In terms of the corporate-bond activity that we have been seeing of late, I remember at the onset of the pandemic we had quite a number of companies going to the bond market to raise money. I’m told it’s one of the cheaper forms of financing out there for big corporates to take advantage of. I just want to know what the kind of corporate activity and issuance is looking like right now.

PETER KENT: It’s quiet. The main sort of issuers in our space aren’t the governments or the banks and the state-owned enterprises; and then there are a few industrial resource-type companies that also issued. But you can imagine issuing debt means you are needing funds to invest or do something, and there hasn’t been a lot of economic activity in the economy because of Covid.

We had a very big recession last year. We’ve managed to bounce back because of the commodity price increases, but activity is still very low. So there’s not a lot of investing that’s happening in the economy, and as a result there are not a lot of people who need the funds.

We would love to see that slew of activity come through the corporate bond markets. We would love that, even though the bond markets would sort of cheapen as a result of it, but that would be a sign that the economy is picking up and people need capital and are going to be investing and deploying that capital. It would be quite a healthy sign if we saw that activity pickup.

FIFI PETERS: I think I will from now on be looking out to see that activity, to see if we see a turn of the times. Peter, thanks so much for joining us. It’s not often that we speak about the bond market on the show, and you gave us a very nice, refreshing view of an important part of the market that we don’t often touch on.

That was Peter Kent, the co-head of SA & Africa Fixed Income at Ninety One.

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