Photographer: Waldo Swiegers/Bloomberg

SocGen Bets on Brexit Result Making South African Bonds a Buy

  • ‘Remain’ victory will be positive for country’s dollar debt
  • Premium compensates holders for downgrade, political risks

A “Remain” vote in Thursday’s Brexit poll would make South African dollar bonds a buy for Societe Generale SA.

Even with yields falling to eight-month lows in June, the bonds are among the cheapest in emerging markets relative to SocGen’s fair-value estimate. They are set to benefit from an increased appetite for riskier assets after the British referendum on European Union membership, according to Regis Chatellier, director of emerging-market credit strategy at the Paris-based lender.

South African dollar bonds have returned 2.5 percent this month compared with the average of 1.7 percent for 66 developing nations tracked by Bloomberg indexes. Yields on benchmark securities due September 2025 dropped 35 basis points in June to 4.66 percent, a premium of 3.47 percentage points over U.S. Treasuries. That’s about 55 basis points cheaper than fair value, according to SocGen, enough to compensate investors for the risk of a potential South African credit rating downgrade later this year, Chatellier said.

“The downgrade is priced in, and in the case of a no-Brexit outcome, then South Africa looks attractive,” Chatellier said from London. “The spread is one of the best in terms of risk-reward you have in the market now. It’s a six-month bet.”

SocGen’s model, which identifies disparities in market pricing, shows South Africa as the cheapest credit after the Ivory Coast and Costa Rica among emerging markets. The nation’s debt could outperform peers in the short term if the U.K. votes on Thursday to remain a member of the EU, an outcome that would encourage investors to buy emerging-market assets.

Dodging Downgrades

Africa’s most-industrialized economy avoided a credit rating cut to sub-investment grade this month when S&P Global Ratings and Fitch Ratings opted to affirm their BBB- assessments. Finance Minister Pravin Gordhan helped bolster sentiment by committing to stabilizing the nation’s debt levels and cutting spending. This has given the nation a six-month stay of execution, with the next set of rating reviews due in December.

By contrast, the view of Global Evolution A/S is that South Africa’s dollar bonds simply don’t compensate investors enough for the downgrade risk and political uncertainty. The Kolding, Denmark-based firm, which manages about $3 billion in assets, says it’s unlikely to change its underweight position, even if the U.K. remains within the EU.

“While we may see South Africa’s dollar debt rally, from a relative perspective we simply see better valuation elsewhere,” said Michael Hansen, senior strategist at Global Evolution. “We would need to see other spreads widening before moving market-weight, or we would have to become more confident in the political and structural reform agenda in South Africa.”

Risk, Caution

SocGen’s Chatellier said his buy recommendation doesn’t mean “things are going the right way” in South Africa, but rather signals that the market is pricing sufficient caution for the risk investors are taking.

“If you compare to other credits with the same kind of fundamentals, then South Africa could appear cheap.”

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