South Africans are currently living through extraordinary times of political and economic crisis.
Coronation’s first priority is ensuring that your investment will withstand the worst of the volatility. We believe we have built robust portfolios that can handle these kinds of shocks. Recent fund performance is testament to this ability.
While South Africa has experienced a currency shock and huge market turmoil over the past ten days, investments in our domestic general equity and multi-asset funds have not lost value.
Still, while we are comfortable that we have stress-tested our portfolios and that our funds can weather further shocks, the current crisis is extremely concerning to us.
Repercussions of recent events
The decision to replace a number of cabinet ministers, including the well-respected finance minister and his deputy, while retaining those who have performed poorly, has caused immense damage to the country’s reputation. The resultant loss of confidence has triggered massive market turmoil and investment outflows. Unfortunately, the first signs of an economic recovery, seen over recent months, won’t survive this turmoil. Hopeful expectations of interest rate cuts later this year may be at risk.
As always, the situation holds the most serious consequences for the poor, who have no defence against the subsequent economic fall-out: higher inflation and interest rates, and a shrinking job pool.
The upheaval has culminated in the loss of South Africa’s foreign currency investment grade rating from Standard & Poor’s. A country’s rating is the agency’s assessment of the government’s ability to meet its debt obligations in a timely manner and this is a clear sign of significant deterioration. Our economy has benefited enormously from this rating over the past 17 years, which has been undone 90 hours after the midnight-hour cabinet reshuffle. The repercussions may be felt for years to come. We expect other ratings agencies to follow suit.
The country needs political commitment to boost confidence and recommit to the sound economic policy pursued by prior ministers of finance. Current policy indications look to deviate from that. Our expectations are of further ratings downgrades, which could happen in quick succession.
Impact on Coronation’s funds
Recent shocks, both abroad and in SA, have proved that the best protection against an uncertain future is investing in a diversified portfolio of undervalued assets. The aim with our multi-asset funds is to build anti-fragile strategies that can withstand unexpected developments. When we manage portfolios, we look at total exposure to major risk events – including sharp movements in currencies, inflation and interest rates.
Our multi-asset funds have remained at close to maximum offshore exposure levels for the past number of years, and within our local equity holdings we have a high representation of companies which earn the majority of their earnings offshore. We have consistently had very little exposure to domestic government bonds as we have felt the pricing was not sufficiently attractive relative to other asset classes. We continue to invest only in assets and instruments that we believe have the correct risk and term premium, to limit investor downside and maximise return.
Times of stress and great emotion in markets often present opportunities to the unemotive long-term investor. However, we continue to remain very cautious and mindful of deterioration in domestic fiscal discipline. We believe that as it stands current valuations do not compensate for the negative fundamental backdrop and uncertainties in South Africa, as well as the potential for a very different set of fiscal strategies, already pronounced on by the new finance minister. Especially concerning is a commitment to an imprudent nuclear energy programme, as reaffirmed earlier today.
What lies ahead for South Africa
History suggests that it takes much longer to regain a lost investment grade rating than to lose it. Only a minority of countries that have lost their investment rating over recent decades have succeeded in gaining it back.
South Africa's investment grade rating was achieved following many years of hard discipline and tough decisions by the ANC government. After inheriting a dysfunctional and over-indebted economy, the first democratic government reined in spending, recapitalised the state pension fund (which had been plundered), and created a transparent long-term budgeting process which anchored fiscal policy to a sustainable path. A new constitution helped provide the framework for economic and legal institutions, and a commitment to growing, entrenching and protecting these institutions helped restore confidence and steered the economy onto a better growth path and a fiscally strong position. Over time, ratings agencies acknowledged the progress and upgraded their sovereign ratings for South Africa, with Moody’s awarding an investment grade status in 1998, and S&P following later in 1999. This helped lower the cost of borrowing and enabled the state to provide basic services and welfare grants to the poor and to reduce its debt.
These achievements have now been undermined. In recent years, there has been considerable fiscal slippage, exacerbated by poorly managed state-owned enterprises. Low growth and deteriorating confidence has in turn contributed to weak employment growth (outside of the state), low private sector investment and growing inequality.
Looking ahead, there are a number of ongoing risks. The first is that ratings downgrades do not tend to happen in isolation – the factors that prompt a downgrade, especially below investment grade, tend to have taken time to develop and carry some momentum, while sufficient remedial action can take years to implement. Secondly, South Africa’s inclusion in the Citi World Government Bond Index (WGBI) – which is a considerable boon for domestic funding – is contingent on two agencies holding the country’s local currency rating above investment grade. At this stage, both S&P and Fitch hold these ratings on the cusp. While this suggests risk is still a little way off, things can deteriorate very quickly.
Our concern is that as the economy deteriorates and unemployment rises due to the effects of the decisions taken, there will be rising discontent from the majority of the population affected. This will likely result in greater levels of civil unrest and increased populist rhetoric and actions from government, which will engender further loss of confidence in South Africa.
History has taught us that our ability to forecast the immediate future is limited. As always, our key focus is on building diversified portfolios of undervalued assets that can withstand shocks, such as those we are currently experiencing. While the unfolding events are understandably uncomfortable, we trust that our focus on ensuring your investment portfolio remains resilient makes it a little easier for you to remain committed to the investment strategy that is most likely to meet your long-term needs.