Believe it or not, South Africa will in all likelihood be downgraded to sub-investment grade this year. But that doesn’t mean we should all pack off to Perth or place all our money offshore. The rating downgrade to sub-investment grade will happen because of South Africa’s lacklustre economic growth. But most of the world is battling with economic growth and a number of countries are in a similar position.
The more critical question facing local and foreign investors alike is whether, despite being downgraded, South Africa can arrest this downward slide or if the downgrade is merely a sign of a lot worse still to come. And while we have little control over the impending downgrade, we have all the control over what happens thereafter.
A downgrade to sub-investment grade is already being priced by financial markets, because South Africa has limited ability to influence its economic growth rate, and global growth is weak. Of course, there are many things we can do better, like relaxing our visa restrictions to make it easier to attract tourists and making sure our physical (for example electricity) and social (for example education) infrastructure can actually support increased economic growth, but none of these on their own will get our growth rate back up above 3 percent per annum while global growth remains weak. We can, however, influence how the international community perceives us, although recent controversies we’ve read about in the media haven’t done us any favours. While the risk associated with South African assets has increased because of heightened political uncertainty, it is harder to answer whether it is sufficiently reflected in the price.
This is because it is incredibly difficult to assign probabilities as to whether the country will be successful in tackling the sustainability of South African debt. Should we fail, the discount on our debt will get substantially larger.
While restoring our credibility will not be an easy road, South Africa today should not be priced as a failed state. We have a number of exceptional politicians, business leaders and civil society activists who can all make a difference.
And as citizens of this country we all have an obligation to hold our politicians to account if they do not meet our reasonable expectations. So do South African assets look attractive? As multi-managers we rely on more than one manager to assess this risk, and therefore our funds have been cautious buyers into this weakness as certain of our managers see more attractive opportunities here. The market though rarely provides us with an opportunity to buy an asset without any downside risk, but the current crisis is providing opportunities for managers to establish positions at discounted prices.
Importantly, we try to construct funds that are not dependent on the ability of politicians or central bankers or even asset managers to get things right all the time. This means our funds are deliberately diversified across geographical regions, markets and companies. In general, this also means we prefer investing with managers where we have a high margin of safety; this often occurs in markets where there is significant gloom as these assets are not being priced to perfection.
In summary, our bond and currency markets are already pricing South Africa as sub-investment grade, but clearly the discount will get substantially larger should the picture further deteriorate.
Should South Africa command a much higher discount than is currently reflected in the pricing of its assets? This is difficult to answer, but the current crisis creates an opportunity for our politicians to turn things around, and for our managers to acquire attractively priced assets should the worse-case scenario not materialise.
This is in contrast with the rest of the world, where trillions of dollars of debt are traded at negative nominal yields and there is considerable risk of capital loss if politicians and central bankers don’t get things exactly right.