Locals on Sidelines as Foreigners Reap S. Africa Debt Rewardby
Yields on bonds are highest among investment-rated countries
Local pension funds hold least government debt since 2013
South Africa is looking better from the outside than the inside, judging by the behavior of bond investors.
Foreign holdings of South African government securities are at the highest in two years, with inflows of 62 billion rand ($4.5 billion) this year, compared with 6 billion rand in the corresponding period last year. By contrast, domestic pension funds, historically the biggest investors in government debt, in August reduced their stock to the lowest since May 2013, according to National Treasury data.
Inflows into domestic bonds have continued even as political turmoil roiled markets, pushing the rand to a record low against the dollar earlier this year. While the global clamor for returns is part of the story -- South African bonds have the highest yields among investment-rated nations, and have posted the best returns this quarter in emerging markets -- the purchases are also a vote of confidence that inflation in the country is under control and that the nation will avoid a credit downgrade to junk amid signs the economy is starting to recover.
“The indicators have turned and they’ll start to show up in the ratings agencies’ models just in time for them not to cut,” said Stephen Bailey-Smith, an investment strategist at Global Evolution Fonds A/S, which manages $4.3 billion. The Kolding, Denmark-based firm is overweight South African government bonds and has seen its assets under management double this year, mostly from European pension funds seeking alternatives to negative-yielding bonds, Bailey-Smith said.
South African government bonds earned 11.2 percent for dollar investors in the third quarter and more than three times the emerging market average of 3.3 percent, according to Bloomberg indexes. Next-best is India, with a return of 7.7 percent. The country’s government bonds yield on average 8.79 percent, more than junk-rated Russia’s 8.43 percent.
Fitch Ratings Ltd. and S&P Global Ratings Ltd., which both rate South Africa at the lowest investment level, are reviewing their assessments in December. With the economy expanding at the slowest pace since the 2009 recession, government debt rising and a political battle over the government’s purse strings simmering, the risk of a downgrade has kept bond yields elevated. Many local investors are over-estimating the risk and missing out on returns, according to Abri du Plessis, a portfolio manager at Cape Town-based Gryphon Asset Management.
Moody’s Investors Service, which rates South Africa’s debt two levels above junk with a negative outlook, said this month the risk of a downgrade is around a third. A 3.3 percent expansion in the economy in the second-quarter and calmer politics, risk factors for the rating, may sway opinion against a cut. There have been few recent developments to feed speculation of conflict between President Jacob Zuma and Finance Minister Pravin Gordhan, which led to concerns the treasury chief may lose his post.
“Foreigners are always more positive about us than we are about ourselves, specifically on the bond side,” Du Plessis said. “Credit raters are behind the curve, and I don’t think that local managers are pricing that in. I don’t think anything will happen that will force them to downgrade us. Zuma and Gordhan will make up and sort one another out and it will be business as usual.”
Bonds fell and investors sold the rand in late August as fears peaked that Gordhan faced police investigation and possible removal. Yields have since fallen 40 basis points in September, while the rand is the best performing currency against the dollar in the world among more than 140 tracked by Bloomberg. The South African Reserve Bank last week predicted inflation would be lower this year and next than they forecast in July.
Aberdeen Asset Management, which oversees $403 billion of assets, including South African government bonds and debt sold by state power producer Eskom Holdings SOC Ltd., are “happy holders at these levels,” said Edwin Gutierrez, the firm’s head of emerging-market sovereign debt in London.
The weaker rand’s “pass-through to inflation was never as high as expected,” and with inflation coming in better than forecast, the central bank’s next interest-rate move could be to cut, Gutierrez said. Aberdeen would consider adding to its holdings of South African debt if the yield on the benchmark 10-year bond breached 9 percent. It rose 3 basis points to 8.71 percent by 12:52 p.m. in Johannesburg.
The search among foreign investors for returns as developed nations from the U.S. to Japan hold interest rates at or near record lows should help sustain purchases of South African debt, said Global Evolution’s Bailey-Smith.
“We are seeing a search for yield and I don’t think it’s going to end abruptly, and I certainly don’t think the Fed possibly raising rates another 25 basis points would scupper that bullish tone,” he said.