Events of the past few days have reminded South Africans how dependent we are on the reform agenda of the ruling party, and how financial markets do not like political uncertainty. While our base view is that the muddle-through scenario is still the most probable, there is clearly the possibility that the reform agenda is reversed, or even (and we think this is less likely) an emboldened Ramaphosa finally implements decisive reform.
Fortunately, we hold diversified portfolios on behalf of our investors, and market expectations prior to Phala Phala were, that structural reforms lacked urgency. While the probability has increased that reforms could be reversed (particularly if Ramaphosa were to resign or be forced out) we are already receiving considerable compensation for taking on SA-specific risk, and there are other geo-political risks also to be concerned with.
Taking these risks into account, we reduced our SA bond exposure in April this year from a large overweight, on the back of weak structural reforms and increasing relative attractiveness of cash, but more recently have been reducing SA equities and foreign equities into strength. These asset allocation decisions have increased our SA and foreign cash exposure and better position our portfolios should market conditions deteriorate further.
In short, while we have maintained an overweight to SA bonds given their attractive valuations, the size of this position has reduced as our confidence in the reform agenda has weakened, and SA cash has become more attractive. In addition, we may continue to reduce our equities exposure into strength, especially if we assess that the global economic outlook could deteriorate further. Given that our portfolios are more defensive than we have been in the past, they should provide more protection should conditions deteriorate further, while still performing if conditions turn out better than expected.
Investors in 2022 are not only concerned with the robustness of SA institutions but there are significant global geopolitical risks that could increase investor uncertainty and reduce economic growth. Given our concern that central banks (including the South African Reserve Bank) may still need to raise short-term interest rates more than the market expects, we have used recent equity market strength to trim our global growth exposure and are moving to a neutral position in SA equities (from overweight).
Importantly, our appointed asset managers have the discretion to implement their best views and can hold equities quite differently from that of the broader market. This means the companies they own on your behalf can be more resilient than those simply in the market benchmark and can make changes to the portfolio should circumstances change.
As a multi-manager, we strive to diversify risk and position ourselves to perform in multiple scenarios. While the recent political news is disheartening, it is not completely unexpected and reminds investors not to construct portfolios overtly dependent on SA turning out better than expected. Despite obvious downside risks, investors should be mindful that the future can also positively surprise and should not position themselves only to benefit if things turn out worse than expected.
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