How are SA funds positioned to withstand further credit downgrades?

Graham Tucker, Balanced Fund Portfolio Manager at Old Mutual Investment Group’s MacroSolutions.

Given the larger-than-expected shortfall in South African government revenues and an increase in foreign financing of government borrowing in rand, the likelihood of a local sovereign downgrade has risen further following the Medium Term Budget Policy Statement (MTBPS); giving rise to critical questions around how South African funds are positioned for such an event.

Graham Tucker, Balanced Fund Portfolio Manager at Old Mutual Investment Group’s MacroSolutions, says that while the potential of further downgrades may be priced into some assets, this is not true across the board and the impact of such an event could therefore be significant.

“A downgrade to sub-investment grade by S&P and Moody’s would see South Africa removed from the global bond benchmark indices. Passive investors would be required to disinvest on the back of this, leading to significant foreign selling of local bonds within a short time period, thereby driving up bond yields. This would in turn put pressure on the currency and could lead to a significant depreciation in the rand.”

Tucker points out: “Given the already high yield offered by our bonds, many foreign and local investors managing active funds could invest into our bonds believing that they are being sufficiently compensated for the risk. Therefore, you may witness a sell-off in our bonds initially, but thereafter we wouldn’t be surprised to see them find a ceiling (in terms of yield) or even strengthen somewhat on the back of this.”

Nevertheless, Tucker says that the positioning of the Balanced Fund reflects their cautious view on South Africa going forward. “This is a long held view that South Africa is in desperate need of structural reform in order to improve the overall health of the country. As we’ve seen in recent times, our growth rate has continued to slide and is well below potential. This year is particularly unfortunate in that we’ve been unable to accelerate along with the rest of the world. This follows a mediocre 2016 which saw just 0.3% real growth in the economy.

Tucker goes on to highlight the importance of not confusing the economy with the market. “Many of the companies listed on the JSE operate globally with little to no exposure to the local economy. It is also important to remember that we are investing a quarter of our clients’ savings directly in offshore markets. Should the rand weaken on bad economic news, that portion of their investment should gain in value.”

Tucker concludes “Over the year we’ve used opportunities to rotate from SA-facing areas of the markets to globally focused investments. This means increasing our offshore exposure and reducing our holding primarily in banks and bonds. As such, we believe that our clients will be fairly well protected in the event of a downgrade.”