How investable is South Africa right now?
South African assets are priced cheaply, partly because investors are not convinced that government has the appetite to drive through the necessary structural reforms, and nominal economic growth remains far below the cost of government funding. The question investors would be asking is does this make South Africa a good investment opportunity?
Clearly, if structural reforms do take place, then investors will be handsomely rewarded for taking on South African risk at these valuation levels. We think this scenario is unlikely, at least in the short term, because the most probable election outcome either leaves the ANC in a coalition or with the majority neither of which is likely to create an environment of lasting structural reform. However, a lot of bad news is already in the price, and the bar for positive surprises is quite low. This should make one cautious about writing off South Africa completely, as we could benefit significantly if a few things go in our favour.
Overall, we are still cautious about South African assets in our portfolios, despite their attractive valuations, and tend to favour South African cash over other South African assets where we have discretion relative to our strategic asset allocation. This also does not mean there aren’t attractive investment opportunities on the JSE, or unlisted companies that can generate outsized returns for investors. But it does mean that the general environment is still not favourable for South Africa.
Investors expect risk premiums associated with emerging markets like South Africa, so are investors being compensated and is the ROI worth it?
The returns on offer in South Africa are significant. Five or 10 years ago, if we were told that we could get 5% real returns on South African bonds, most of us would have banked that immediately. The challenge is whether our debt is on a sustainable path – there has been no evidence so far that government has got a grip on this – but in five or 10 years’ time one can easily see a scenario where investors challenge us for not having taken more advantage of the opportunity on offer today.
On a medium- to long-term view (10 to 15 years), I don’t think it is outlandish to think that we will be able to implement economic reforms. We will then be able to pick up growth and start performing. If that is the case, this is a great entry point for South African assets. However, if we have another 10 years like we’ve had up until now, we aren’t getting enough compensation for holding South African assets, even at these high yields.
Today, it is difficult to say with conviction which scenario will materialise. When we build portfolios, we try to consider both outcomes, as we don’t want to take on a binary call where we are backing one view. Having said that, if we had greater conviction in the reform agenda in South Africa we would have a higher weighting to South African assets than we do currently.
Please tell us how your view on local assets impacts your offshore allocation.
One does not want all one’s portfolio exposed to South African-specific risk, and an allocation to offshore can help reduce that. So even though South African assets are inexpensive, it still makes sense to allocate offshore to help diversify one’s portfolio. When the regulations changed a year and a half ago to allow 45% offshore in retirement funds, it was a big change for South African investors. It allowed us to hold a lot more offshore than we have held in the past; in a multi-asset high portfolio where most retirement savings are for example, our strategic asset allocation now splits our 70% equity allocation equally between South African equities and offshore equities.
Some might argue that this is still a high allocation to South African equities, given how small and concentrated the South African market is, but it is a lot less South African equity than we would have held in the past. Offshore, we have tended to favour global equities over other asset classes, but today we also have an allocation to offshore bonds and cash in most of our portfolios. The allocation to global bonds is relatively recent, as valuations until recently have been underwhelming.
Locally, relative to our strategic asset allocation, we are only overweight South African cash, as we remain concerned with South African-specific risk. In contrast, our global allocation is overweight offshore cash and bonds, as equity valuations are not inexpensive. So, overall, our portfolios are cautiously positioned. While we are holding more cash than typical, we would look to deploy cash in times of market weakness, which is our base case for this year given the potential for short-term volatility in the market.
Lastly, please elaborate on how being a mutual impacts your investment process and solution.
PPS has been around for more than 80 years and one thing we have learnt is thinking long-term differentiates us from everybody else. Our profit-share is available to qualifying members at retirement to help augment their life savings, and our investment solution mindset aims to cater for different eventualities on the road to financial freedom.
As the mutual that serves the professionals that serve South Africa, we are very much focused on education as the most effective way of building resilience for South Africa, and it’s a critical component of ensuring South Africa will be a good investment in 10 or 20 years. At PPS, we are focused on ensuring that we have a big stream of professionals who continue to help grow the economy in our country. As a mutual, we can take a long-term perspective on that because we can look at the whole education ecosystem and where we should best intervene to try to help sustain it.
So, I think that the most important thing about a mutual is it takes a long-term perspective. We are an intergenerational mutual. We are owned by our members and we are owned by the professionals that serve South Africa – today’s and tomorrow’s professionals. By its very nature, a mutual needs to look long-term and that impacts how we invest and how we think about investing because we realise we are playing an infinite game.
