Foreign investors prefer SA bonds to equities

While the stellar equity returns during January and February came as somewhat of a surprise, the implications for emerging markets have been rather beneficial, says Luigi Marinus, head of research at Plexus Asset Management.

“As the European situation has gone through its ups and downs, market participants have applied a risk-on versus risk-off scenario. This is clearly evident in the flows into and out of South African financial markets,” says Marinus.

According to Marinus, last week is of particular importance, with a large inflow into the local bond market. “This occurred as a result of Europe agreeing that Greece had met the requirements to receive the second portion of its bail-out package.

“With extra liquidity being available, the interest rates attainable in emerging markets and particularly South Africa have proven to be very enticing to foreign investors, representing a risk-on trade.”

Interestingly, the net flows into the South African equity market by foreign investors have been negative for the year to date. “This could be for three basic reasons,” says Marinus.

“Foreigners may believe emerging markets are too risky, or the risk premium on South African equities is not worthwhile compared to the yields available on South African bonds. Or there are better opportunities outside South Africa in the emerging-market equity space,” he says.

“The Emerging Markets Index has outperformed the MSCI World Index by roughly 6% during the past two and a half months,” Marinus points out. “This would suggest that the risk-on scenario is providing opportunities for investors to acquire emerging-market exposure.

“While the FTSE/JSE All Share Index has delivered excellent returns since the beginning of the year, foreigners seem to have preferred South African bonds and other emerging-market equities to South African equities,” says Marinus. “This does not necessarily imply that our equities are expensive; it just means investors are finding other options in the emerging-market space that may offer more value at this time.

With the rand being relatively strong at this stage, he notes that South African investors might want to use this opportunity to diversify a portion of their investment portfolios into other emerging markets.

Graph A

The weekly net flows into and out of the domestic bond and equity markets, with the rand versus US dollar exchange rate superimposed.  

Graph B

The performance of the MSCI World Index and the MSCI Emerging Markets Index in US dollars since the beginning of 2012.