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SA gets win-some-lose-some feeling in bond-market lure

Investors pile into government bonds, but money flows out again as they dump stocks.

It’s now you see it now you don’t when it comes to South African investment flows.

As the country’s growth outlook worsens, foreign investors are piling into government bonds to profit from junk-level returns on debt that’s rated investment grade. Yet all of that money is flowing out again as investors dump stocks at the fastest pace in at least ten years.

Foreigners have bought a net R35.7 billion ($2.46 billion) of South African government debt this year, while selling R35.6 billion of stocks, according to securities exchange data up to April 22. South African local bonds have provided the third best returns among 31 emerging market nations’ debt this year, with benchmark ten-year yields the highest after Russia and Brazil out of 27 developing nations tracked by Bloomberg. 

South Africa’s growth forecast has been cut twice this year by the International Monetary Fund as low commodity prices, rising borrowing costs and a drought weigh on the economy. President Jacob Zuma’s decision to fire his finance minister in December made matters worse, raising questions his commitment to fiscal targets. With interest rates near or below zero in many developed nations, South African yields, which are higher than those of junk-rated Russia, are looking an attractive alternative to stocks, according to Pioneer Investment Management.

“Growth has been downgraded, the tendency is that the equity market is negatively affected and duration risk takers are becoming more brave,” said Hakan Aksoy, a bond fund manager at London-based Pioneer. “The overall rate market is quite dovish, rates are going down,” fueling demand for South African bonds, he said.

South Africa’s economy last year expanded at the lowest rate since a recession in 2009 and is set to post just 0.8% growth this year, according to central bank forecasts. The IMF is even more pessimistic about growth in Africa’s most-industrialised economy, cutting its forecast for the year to 0.6% on April 12, from 0.7% in January.

Food Prices

The worst drought in a century has boosted food prices, pushing inflation above the central bank’s 3% to 6% target range. A persistent breach would require a further policy response after the central bank raised the benchmark rate by 1.25 basis points since July, Deputy Governor Daniel Mminele said last week. That will leave consumers with less to spend, affecting corporate earnings, said Mokgatla Madisha, head of fixed-income investments at Argon Asset Management in Cape Town.

“Growth in South Africa is continuously being revised down, so if you’re an equity investor looking to take advantage of South African growth, or even growth on the continent, you’ll probably be a little bit disappointed,” Madisha said. Even with the inflation rate above 6%, South African bond yields higher than 9% remain attractive to investors, he said.

Those yields are also high enough to compensate investors for the risk of a credit rating downgrade to junk. Standard & Poor’s is reviewing its BBB- ranking, the lowest investment level, in June. A downgrade may hurt equities more than bonds, according to Abri Du Plessis, a money manager at Gryphon Asset Management in Cape Town. South African government bonds have returned 7.7% this year, compared with the 3.1% return for the benchmark stock index.

“There’s always investors who don’t worry whether we’ve got investment grade or not,” Du Plessis said. “We’ve still got quite good yields. At a yield of 8 to 9% it’s always great comparing yourself to what’s around in developed markets.”

© 2016 Bloomberg

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