Is South Africa investable?

For the last year or so, following regulatory crackdowns, Covid lockdowns, slowing growth and growing strategic competition with the West, many investment commentators have posed the question “Is China investable?” This question can just as easily be asked of South Africa, not only by foreign investors, but by locals too.

Investors are always told to leave their emotions aside when thinking about their money. This is hard at the best of times but particularly difficult when things around you literally seem to be falling apart. How can you invest in a country where there is no reliable electricity, crime and corruption seems to be out of control and dodging potholes has become an essential skill?

Meanwhile, the only growth industry, apart from installing inverters, appears to be commentors warning that we are on the precipice, peering over the edge, at a tipping point – insert your metaphor of choice.

To take the emotion out of it – or at least try to – let’s not think like South Africans, but like New Yorkers. Picture a fund manager on Wall Street. How would they approach this question?

The first consideration for our hypothetical New Yorker has nothing at all to do with South Africa. It is about the global investment landscape, dominated of course by the US and American monetary policy. When US interest rates rise, as they’ve done sharply over the last year, every single asset class on earth has to reprice directly or indirectly. This is because of the singular role of the dollar in global finance, with US interest rates simply begin the cost of borrowing dollars.

This global landscape, which includes growth prospects in the major economies – US, China, Europe, Japan – will determine how much risk our investor is willing to take, and what the split between bonds and equites will be, for instance. It will also influence how much emerging market exposure our New Yorker will take on.

Typically, capital flows to emerging markets (EM) when risk appetite is strong, US rates are low and growth prospects solid. Clearly, the global backdrop of late has been exactly the opposite as interest rates have increased across the developed world, risk aversion has been high and growth has been under pressure, firstly due to Covid (with lockdowns in China only ending recently) and then the war in Ukraine causing energy and food prices to spike.

The combination of these factors has also led to a very strong dollar. When the dollar is strong, it tends to depress economic activity in emerging markets, but it also depresses returns for our friend in New York who must translate local currency returns generated outside America back into dollars. If the dollar gains against the yen, for instance, Japanese returns decline from the point of view of American shareholders. In contrast, a weaker dollar will boost those returns (This is of course the opposite effect that South African investors experience. When the dollar is strong and the rand weak, our global investment returns are boosted).

To the moon
Only now do we get to South Africa. SA asset classes are a small subset of emerging markets (EM) which is a small subset of global markets. Chart one presents a simplified version of this picture. What matters is therefore how EM are placed within the global context, and then how SA is placed in the EM context. Too many local investors start by thinking about South Africa in isolation. This is a bit like the pre-Copernican view of the earth as the centre of the universe. Instead, the earth is a small planet in a solar system dominated by a massive sun. Global markets (US markets to be more accurate) are the sun, EM revolve around it and South Africa is a moon that orbit around planet EM.

To put some numbers to it, South Africa’s weight in the MSCI Emerging Markets Index is now barely 4%, down from 7% largely due to China’s increased importance. In the overall MSCI All Country World Index, our global equity benchmark, SA’s weight is less than 1%. The US is at a sun-like 60%.

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