Rand’s Fall Stokes Best EM Stocks Rally: Riskless ReturnJaco Visser
South Africa, hit by the worst decline among major currencies this year, is rewarding emerging-market investors who have hedged against exchange-rate swings with the best stock-market performance.
The FTSE/JSE Africa All-Share Index returned 4.1 percent in the three years through Oct. 15, after adjusting for volatility, the highest among 22 developing-nation measures, according to BLOOMBERG RISKLESS RETURN RANKING. South Africa beat Malaysia’s FTSE Bursa Malaysia KLCI gauge, which had a risk-adjusted gain of 3.8 percent, and the Philippines, which had the best total return.
The shares surged as pension funds, barred by law from putting more than 25 percent of their money outside the country, bought stocks with foreign earnings, which benefit when dollar income is converted into rand. The four largest companies by market value on the FTSE/JSE Africa All-Share Index, accounting for 42 percent of the index, are foreign domiciled and make most of their income abroad, including BHP Billiton Plc, the world’s largest mining company, and Cie. Financiere Richemont SA, the largest jewelry maker.
“Without a doubt the main reason is currency,” Paul Attwood, who helps oversee $330 million of assets at Cincinnati-based Huntington Asset Advisors, said by phone Aug. 29. “You also have some pretty good growth rates in some of these companies.”
The rand has led a drop against the dollar among 16 major currencies tracked by Bloomberg and is the worst emerging-market currency after Argentina’s peso, slumping 15 percent this year.
That’s helping boost earnings for companies with a large share of foreign income when converted back into the local currency, including Sasol Ltd., the world’s largest producer of motor fuel from coal, and Naspers Ltd., which owns 34 percent of Tencent Holdings Ltd., China’s largest Internet business.
Foreign-domiciled companies on the Johannesburg exchange include SABMiller Plc, the second-largest brewer, and British American Tobacco Plc, Europe’s biggest cigarette-maker, in addition to BHP Billiton and Richemont.
South Africa’s all-share gauge returned 63 percent, including dividends, over the past three years, the best performance among emerging markets after the Philippine Stock Exchange Index and Thailand’s SET. The benchmark had the third-lowest volatility over the period, trailing the Malaysian gauge and Moroccan MADEX Free Float Index. The returns are in local currency and don’t include the impact of exchange-rate swings.
“One of the main reasons for the lower volatility in the market is because the rand is a risk currency,” Rhynhardt Roodt, a portfolio manager at Investec Asset Management, which oversees about $105 billion, said by phone from Cape Town. “When markets fall, the rand weakens and it cushions the large rand-hedge shares from declining.”
While the African National Congress-led government has loosened apartheid-era foreign-exchange controls since taking power after all-race elections in 1994, some restrictions on taking money out of the country remain. The rules were aimed at avoiding capital flight when sanctions were imposed on South Africa during minority white rule. Individual citizens can take up to 4 million rand ($403,000) a year out of the country.
“By forcing retirement funds to invest 75 percent of their money in South Africa,” the government pushes investors into buying local assets, Alwyn van der Merwe, director for investments at Sanlam Private Investments, which manages the equivalent of $7 billion, said by phone from Cape Town.
Sasol, the third-biggest South African company on the Johannesburg Stock Exchange, gains about 860 million rand in operating profit for every 10 South African cents the currency weakens, the company said in March. Operating profit excluding one-time items surged a record 26 percent in the year through June, Johannesburg-based Sasol said Sept. 9. The stock has gained 38 percent this year.
For Naspers, the nation’s largest company by market value, the weaker rand contributed half of the 23 percent growth in adjusted net income for the year through March, Chief Financial Officer Steve Pacak said by phone from Cape Town Aug. 23. The shares have rallied 76 percent this year, the second-best performer after Johannesburg-based Mondi Group, a maker of paper and packaging, on the FTSE/JSE Top40 Index of South Africa’s biggest and most liquid equities.
The risk-adjusted return, which isn’t annualized, is calculated by dividing total return by volatility, or the degree of daily price-swing variation, giving a measure of income per unit of risk. A higher volatility means the price of an asset can swing dramatically in a short period of time, increasing the potential for unexpected losses compared with a security whose price moves at a steady rate.
The rand’s slump is hurting dollar investors in South African equities, crimping total returns on the all-share index this year to negative 0.9 percent in the U.S. currency, according to data compiled by Bloomberg. The gauge rose 13 percent in rand this year.
“While the stocks have done pretty well, their returns haven’t been great,” Derrick Irwin, a portfolio manager of the Wells Fargo Advantage Emerging Markets Equity Fund, said by phone from Boston Aug. 27. “They’ve given it back to the South African rand.”
The benchmark index has risen even as growth in Africa’s biggest economy is forecast to slow to 2 percent this year from 2.5 percent 2012. That would be the slowest pace since the recession in 2009 and less than half the 7 percent growth the government says is needed to curb a 25.6 percent unemployment rate.
Labor unrest at mines in the country, which has the world’s largest-known reserves of platinum and chrome and is the sixth-largest gold producer, shaved 0.3 percentage point off economic growth this year, according to President Jacob Zuma. The 21-member FTSE/JSE Africa Resources Index has dropped 3.4 percent this year, led lower by Harmony Gold Mining Co., which slid 56 percent, and Gold Fields Ltd., which fell 52 percent.
“These companies were hit by lower dollar prices for commodities and labor disruptions at mines,” Investec’s Roodt said. “If it wasn’t for these issues, you would’ve seen a significantly better performance in rand terms for the all-share index.”
South Africa’s fiscal- and current-account deficits, together with slowing growth and high inflation, leave it vulnerable to external shocks, Mohammed Nalla, head of strategic research at Nedbank Group Ltd. in Johannesburg, wrote in a Sept. 2 report.
The shortfall on the current-account, the broadest measure of trade in goods and services, widened to 6.5 percent of gross domestic product in the second quarter. The budget deficit for the year that ends March will probably be 4.1 percent, according to the median estimate of 12 economists surveyed by Bloomberg in the week through Sept. 25. Inflation accelerated to 6.4 percent in August, the highest in four years, and above the central bank’s 6 percent upper limit.
South Africa’s economy will probably grow by 3 percent next year as Europe’s expansion gains momentum, Sanlam’s van der Merwe said. This will boost commodity prices and probably support mining stocks, which was an “unbelievably disappointing sector” over the past three years, he said, highlighting South African banks as another industry that might outperform industrial and consumer stocks in 2014.
The rand, the most volatile among the majors, may weaken to 10.10 per dollar by the end of the year, according to the median estimate of 31 analysts. The rand gained 1 percent to 9.8808 per dollar by 4:23 p.m. in Johannesburg.
The currency’s slump made it the second-worst performer after the Sudanese pound, among 24 major African currencies tracked by Bloomberg. The Ghanaian cedi weakened 13 percent, the Malawian kwacha slipped 11 percent, while the Somalian shilling, the best performer, gained 30 percent and the Ugandan shilling advanced 5.3 percent.
The rand’s decline relative to other African currencies is helping South African companies, including Shoprite Holdings Ltd., Africa’s largest grocer, and MTN Group Ltd., the continent’s biggest mobile-phone operator, which have been expanding across Africa to boost sales. Cape Town-based Shoprite increased the proportion of its sales from outside South Africa to 14 percent of total revenue in the 12 months through June compared with 12 percent the previous year.
“A lot of the attraction for international investors in South African equities is the exposure to some of the high-growth areas in the other parts of Africa, which a lot of these companies have,” Attwood from Huntington said.
Foreign inflows into South Africa’s stock market this year have surged eightfold compared with the same period a year earlier, with 28.2 billion rand of purchases, data from the Johannesburg Stock Exchange show. That helped push the all-share index to a record on Sept. 25 and valuing the MSCI South Africa Index at 15 times estimated earnings compared with 12 for the MSCI Emerging Markets Index.
“From local investors’ perspective, stocks are doing great,” Chris Gilmour, an analyst at Barclays Plc unit Absa Asset Management Private Clients, said by phone from Johannesburg on Oct. 4. “The rand should weaken, and, as most of the top-20 shares derive a large part of their earnings from offshore, our market should definitely go higher.”