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Post-downgrade strategies for investors

Those who are geared towards income can beef up interest-carrying instruments – Richus Nel.

RYK VAN NIEKERK: Welcome to this Financial Advisor podcast, my guest today is Richus Nel of Brenthurst Wealth. He has been in the financial services industry since 2004 and he’s worked for several institutions, including Investec Trust. He has worked in South Africa, as well as the Channel Islands and Geneva, of all places. Richus is currently the head of Brenthurst Wealth’s office in Tyger Valley, Cape Town. Richus, welcome to the show. Magnus Heystek, the head of Brenthurst Wealth, wrote a very negative blog on Moneyweb and he talks of a financial tsunami heading towards South Africa, do you share his views?

RICHUS NEL: Hello, Ryk, I actually do to an extent, I think what we haven’t seen from the downgrade process is the negative implications that are going to roll out over the coming 12 to 18 months. Everyone is waiting in tension with Moody’s assessment, it doesn’t look very positive at this stage. I’ve attended quite a few seminars where this downgrade is discussed, it is very clear that the negative implications have not taken a footing in the South African economy and rests really on the rating agency, Moody’s, assessment, which is coming out probably within the next month or two. So I think very negative as well from my side. However, I do want to underline from my side to say I think the long-term strategy of investors should be emphasised and reviewed during this time, but there is nothing wrong for me to reduce at this stage.

RYK VAN NIEKERK: The point in the article is that most investment advice is overly biased towards equities and that maybe it’s time for investors to be slightly more conservative and move some money towards cash. What is your view on that?

RICHUS NEL: I do share that view, I think equities and other risk assets like listed property have done extremely well in the interest-reducing cycle that cycle has clearly changed, internationally and nationally. Interest-bearing investments are looking attractive at these levels. I must just add that other than cash, your fixed interest instruments, like bonds, could be extremely risky at this stage still ahead of a further downgrade. So it’s a matter of understanding moving out of equities is not necessarily moving completely away from any risk components in financial markets. 

RYK VAN NIEKERK: How should investors then look at the next six to 18 months? We have had two downgrades, we are, of course, waiting for Moody’s, but the immediate reaction was negative but the rand has, for example, strengthened, on Monday morning it was trading stronger than R13/US$, how do you think things will play out over the short and medium term and what should investors do to try and reduce the risks that may follow?

RICHUS NEL: Ryk, I think it’s very important just to understand what the rating downgrade has meant up until now. It’s been said quite a few times that we need to understand the mechanics between our foreign currency bond issue and our local currency debt or bond issue and that 90% of our foreign debt is issued via our local currency. So that’s a very important part, the second part…

RYK VAN NIEKERK: Can you just elaborate, explain exactly what that means?

RICHUS NEL: That means that even foreigners investing into our bond market in South Africa would have routed it through a rand instrument. Now, our rand-dominated bond credit rating is not junk status or speculative status yet on Moody’s side, neither so on the S&P, Standard & Poor’s. So from that respect I also want to say that the horse has not bolted yet and with Standard & Poor’s it’s still one notch above junk status and with Moody’s it’s still two notches above junk status. Fitch doesn’t make a distinction, so they say foreign or local currency debt is one credit rating, so for that purpose they have downgraded our local currency debt already.

But then a very important part to understand is that almost 90% of all our debt issues and bond issues that’s been taken up by foreigners based the asset allocation on the Citibank index and they rely on S&P and on Moody’s, and on both of them to give a credit rating to say whether someone is speculative or investment grade. Now, if you look at that, as I said, half of the horse has bolted, the move of asset allocation and, let’s say, retreat of asset allocation out of South Africa has not happened because Moody’s has not expressed a credit rating yet. So from that respect we haven’t seen the big outflows yet. As I say, the risk and the concerns that Magnus is sharing on the website and an our media is really leaning on what Moody’s says next and that will be very negative if they further downgrade us from where we are at the moment.

RYK VAN NIEKERK: But if Magnus is right, and I most definitely don’t think he is right, I think he’s slightly alarmist, but let’s say he is right, we get another downgrade and there is a massive outflow foreigners’ investments from South Africa that would trigger a rand weakness. What should investors do now, it seems like we have a month or two months to prepare for this eventuality?

RICHUS NEL: The complexity here and the challenge really is if we talk about investors we are not talking about the same thing, you get investors who are lying in cash at the moment and they need to decide whether they want to deploy that cash into market or not, you’re talking about investors who invest for speculative or spare capital, then you talk about investors who are trying to build up their retirement capital, then you also refer to clients who are retired at the moment. There are many more types of investors but for all four of those there would be different strategies. So it’s very important to break this down and unpacking what would be suitable for whom. If someone is in cash at the moment, if we are further downgraded and remaining in cash then obviously from a buying power consideration that client will lose out considerably. Investors who are in the market currently…

RYK VAN NIEKERK: But what should that person do if they are in cash?

RICHUS NEL: Well, there are two strategies and really that comes back to what is the timeframe that someone is wanting to expect and want to see investment results, they need to determine do they have any market risk capacity at the moment. If they haven’t then they have got no other option but to remain in cash. If they have got a long-term view, and if you ask me this is almost the only scenario that you can with peace of mind go to the market at the moment, if you have got a time horizon of eight to ten years and longer and moving that out of cash because markets internationally are high so you run this risk that markets can come off and obviously trying to protect your rand investment you naturally need to go offshore.

So it’s a little bit of a tricky one, there are not obvious destinations where you can move into that’s a safe and a low risk expectation and investors need to understand that. So linking onto that then structured products are probably not a bad alternative. You’ll see in the marketing outlets you’ll see more and more service providers actually launching these structured products where, let’s say, two or three years ago it was quite uncommon and unpopular.

So from my perspective I think a capital preservation hat needs to be worn at the moment by investors and whether that’s in cash but understanding that you are running the currency risk or in markets and understanding that you might be helping on your investment and protecting it from a rand perspective, but that you are running the risk of higher international markets financially and that you have to have a longer time horizon.

RYK VAN NIEKERK: The second type of investor you have identified are those with discretionary investments, not part of a pension scheme, what should those investors do?

RICHUS NEL: Naturally that will also link onto the time horizon, the longer the time horizon someone hasn’t got an option to really avoid risk assets, but they also need to understand that that will come with volatility and to understand volatility and really just explaining it practically is understand that any asset manager needs volatility to beat the market, otherwise he can really just go into an investment tracker or index tracker fund, an ETF, and really just get the market return. So volatility is not bad but you have to have that time horizon really to be able to stomach that volatility.

RYK VAN NIEKERK: But there’s a difference between volatility and a 20% correction, which many people forecast for the US market, for example, having said that, there are always people calling a 20% correction from the US market. But surely the upside or the possibility that share markets or equity markets shoot the lights out over the next 12 months is limited.

RICHUS NEL: I agree with that and I think that’s also why we are saying cut back on risk and look at more certainty and consider fixed interest instruments. But having said that, you cannot avoid risk asset classes like equity and property if you are an investor for the long-term. It comes back to time horizon and time consideration of what you are wanting to and able to expect investment results. But if you look at a 100-year track record, yes, it’s uncertain at the moment, yes, there is building pressure internationally and locally and so on, and during these times I think it’s very important just to reaffirm that these sorts of difficult times shouldn’t let us forget that we’ve been in uncertain times and that the track record of risk assets are very clear and that that’s one of the only ways to really build well for clients over the long term.

RYK VAN NIEKERK: Yes, don’t try and time the market, it’s virtually impossible.

RICHUS NEL: Correct.

RYK VAN NIEKERK: The last category is people who have retired, they have their products probably geared towards income, what should they do?

RICHUS NEL: They have to find income in essence and that’s very difficult at the moment, especially income that is inflation beating. We are fortunate in South Africa – if I say fortunate it’s probably ironic in calling it fortunate – but our fixed interest rates are relatively high and there are some of them that are actually inflation beating. So what we prefer to do is build up a proportion within each portfolio that can actually sustain an income draw for two or three years, irrespective of a market correction.

But having said that, earlier I said that these instruments are also risky, especially in the face of a downgrade, and it’s prudent to diversify properly. That’s why I’m saying one has to be careful not to deviate too far away from a client’s long-term positioning, but I agree with you, there’s nothing wrong to feel that equities are probably not going to deliver what we want them to over the next 12 to 18 months and that you can beef up your interest-carrying instruments in your portfolio at least just trying to generate some income that you know is going to be necessary for these types of clients.

RYK VAN NIEKERK: Thank you, Richus. That was Richus Nel of Brenthurst Wealth.

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Excellent Richus.

Looks like the boykies from Tygervalley are giving the Stellenbosch boykies a go for their money.

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