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See the investment opportunity in SA through the noise

If you can take a long-term view.

Both politically and economically, South Africa is facing challenging times. Many investors are treating local assets with a great deal of caution.

The political risk in the country was most clearly demonstrated by the dismissal of finance minister Nhlanhla Nene in December 2015. That caused a sharp selloff in the local bond market, with yields on ten-year bonds spiking to over 10%.

Yields have since come back down under 9%, but a lot of uncertainty remains. However, for the head of fixed income at PSG Asset Management, Ian Scott, these conditions are creating an investment opportunity.

“It’s important to separate the noise of politics from the reality of bonds in South Africa,” says Scott. “For us, when bond yields were trading at between 6.0% and 6.5% in 2013 and you weren’t seeing any real yield above inflation, that’s when there was a lot of risk in bond markets. But when there is a lot of fear and uncertainty and yields selloff, as they have, that’s when we think there’s opportunity and bonds are actually less risky.”

He argues that the political uncertainty and fears around the currency and inflation are already reflected in the price. This is why the current yield on government bonds is both above the long-term average and the medium-term outlook for inflation.

“We don’t necessarily know what the reality will be, but when risk is already priced in then we believe there is opportunity,” Scott says. “So when you have yields at close to 9.0% and long-term inflation averages 6.0%, we think that bonds are less risky now than they were a few years ago.”

He adds out that in relation to other emerging markets, South Africa is in fairly good shape. In a peer group that includes the likes of Russia, Brazil and Turkey, the country has three important advantages.

“The first is that our debt to GDP ratio at around 50% is not that bad compared to other emerging markets,” Scott argues. “So we’re not too concerned about the risk of default. We’re confident that we are going to get our money back.

Secondly, the significant majority of South Africa’s debt is rand-denominated. Its hard currency commitments are relatively small.

“Only 9% of our bonds are financed offshore,” Scott says. “So we’re not exposed to dollar-denominated debt where, if we had to refinance it, we would have to do so into a rising interest rate market.”

And finally the institutions that matter in South Africa, specifically the South African Reserve Bank (Sarb) and National Treasury, remain steady.

“Notwithstanding that there is a lot of noise, the Sarb has maintained its inflation targeting and has stuck to that mandate independently,” Scott points out. “Treasury also produced a budget that was neutral to positive for bonds.”

PSG also believes that the risks in bond markets are more balanced than they were last year.

“We felt that a lot of the risks in 2016 were from domestic events,” says Scott. “But in 2017, a lot of the risks are external – like the changing rate cycle in the US, rising inflation in developed markets, and the uncertain politics in Europe and the US.”

In relation to developed market bonds, South African bonds also offer more attractive real yields.

“Bond yields in developed markets have been going up, but so has inflation,” Scott explains. “So real yields are still fairly low. But in South Africa we believe that inflation has peaked and will fall over the next year or two. With nominal yields already being high because of the selloff, we think the real yield from South African bonds can rise as inflation falls.”

Therefore instead of sitting in cash, where they might be receiving no real growth after fees and inflation, Scott believes that investors should be allocating capital to South African bonds.

“Ten-year bonds are yielding around 8.75% at the moment, and we think South African inflation is going to average around 5.5% over the next two years,” he says. “So you’re getting CPI plus 3% with good liquidity and a fairly high predictability that you’ll get your money back.”

However, he suggests that this may not be an opportunity that will remain available for a long time.

“As inflation falls, yields will also fall, and the market will price out high real yields,” he says. “So we think it’s a good time for investors to buy South African fixed income assets, because the opportunity will not last for that long.”

This article is brought to you by PSG.

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my contempt for this article – clearly written by a fund manager – knows no bounds. bonds world wide have been smashed since Trump came in. just one of my nyse shares – amazon- is up 11% in 3 months. banks are up even more and as for my bio stock – 67% in THREE MONTHS. there is a special place in hell reserved for these people

Behold. Something I agree with Rob on.

Now stay in Oz, Rob.

@TheSpark, Just ignore Bob in Oz – he is so homesick; there are not enough things Down Under to occupy him!?? It must be such a boring place, unless you like swimming in the sea with dangerous creatures only found there?

mate – I’m going nowhere – esp to a country run by a bunch of corrupt politicians and to a city that will shortly be running out of water

Whew!?? For a moment I thought Bob was leaving Oz and returning to SA? Thank goodness!!???

If we can see the end to state captyre and ANC corruption that would help.

The problem is our noise is a little more than just a phase.

Our president Atul Gupta is real. State Capture is not a fantasy.

This country is on a set path that should never be brushed off as noise.

Remember these words:

First they came for the Socialists, and I did not speak out—
Because I was not a Socialist.

Then they came for the Trade Unionists, and I did not speak out—
Because I was not a Trade Unionist.

Then they came for the Jews, and I did not speak out—
Because I was not a Jew.

Then they came for me—and there was no one left to speak for me.

Or in the words of the Manic Street Preachers: If you tolerate this, then your children will be next.

Mmm indeed Rob. So your point is (i) equities are a better bet or, (ii) USD assets a better bet?

In any case you need to understand why US equities has rallied while US bond yields increased. Normally rising bond yields = higher discount rate = lower equity values. Why did not happen this time? Expectations are that US earnings will increase due to Trumps tax cuts + infrastructure spend. in the short term that may well be the case – but cutting taxes + ramping spend and pissing off the Chinese that currently funds the US economy is never going to be a recipe for long term success.

The bear will eventually get out of its slumber, tech & bio tech will be an interesting space to be in…

only place to be is in us$ and nyse/nasdaq. specifically us banks – (bank of America and goldman sachs); tech stocks like amazon and gooogle. i am also in bio tech stocks – BUT that is a very risky area (just like mine exploration). all the best

Bob, the only place for you to be is NOT on SA web-sites!?? Now butt out and count some sheep!!?

It never gets mentioned that Tax takes up to 45 % of your investment income accrual, so if you for example get 9 %, it is actually 4,95 % that you get and that does not help at all.

in South Africa, you cannot afford to get less than at least 15 % to 18 % gross interest on your money ( net 8,25 % to 9,9%).

Just how is that return possible on a regular basis?

Get a contract to distribute social grants…

Perhaps the jargon conceals the meaning.

“Yields will also fall, and the market will price out high real yields”

So, buy a bond for 1000 at 9% yield and earn 90 pa, taxable. If interest rates drop to 6%, the market price of the bond rises to 1500 for the same income (90). If it takes four years to get there, the total annual return is close to 20%, and (it depends) you may get away with CGT on 11% out of that. Total after-tax return (very roughly) 14% pa.

If.

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