Which way is up?

We find ourselves in a period of flux – post Nenegate, post Downgrade announcements. Post Constitutional Court ruling and pre Municipal elections. Will he go or won’t he go? What does all this mean for your investments?

Many people were predicting a “Downgrade”. It is important to understand exactly what is meant by a downgrade and, while not underestimating the gravity of a downgrade, to keep the issue in perspective. There are three big credit rating agencies;
  • Moody’s,
  • Standard & Poor’s and
  • Fitch.

The issue at stake is their rating of South African government bonds. On Saturday, 7 May 2016 Moody’s sprang something of a surprise by announcing that they had retained their rating of South African government bonds at two levels above Junk Status. It had previously been widely anticipated that Moody’s would bring their rating down one level to be in line with Standard & Poor’s and Fitch. On Friday, 3 June 2016, Standard & Poor’s also announced that they were retaining the current rating. This was followed by Fitch announcing on Wednesday, 8 June 2016 that they would be also retaining their current rating.

We are still however in a relatively weak position as all three rating agencies have effectively given notice that unless the economic outlook for our country improves substantially, and economic policy indicates that there is political will to bring about change, they will downgrade our rating. This situation has given rise to the term, “six months to get on the right path”. What is interesting is that the media made a lot of fuss about the likelihood of a Moody’s downgrade but not nearly as much fuss when Moody’s announced their decision to retain their rating as is for the time being, and even less fuss when S&P announced their decision to retain our current rating. This is another lesson about focusing on the facts and not the “noise”. It is also important to consider the effect of a downgrade to Junk Status. Some large overseas Pension Funds are not permitted to invest in government bonds which are rated at “Junk” level. The implication therefore is that these Pension Funds would have to sell their South African government bonds resulting in a significant capital outflow from South Africa. Significant capital outflows in turn usually precipitate a fall in the Rand/Dollar Exchange Rate. So, a double blow to South Africa. It is also important to note that the rating downgrade applies to government bonds. It does not apply to equity investments or to private sector corporate bonds. While the significance of the capital outflows should not be underestimated, many overseas institutional “pension funds” have been reducing their exposure to South African government bonds and reallocating the money to private sector corporate bonds such as those issued by the big banks, big retailers and big industrial companies. South African fund managers have in turn also reduced their exposure to South African bonds in favour of corporate bonds. The anticipated downgrade once again highlights the necessity to make full use of the full 25% offshore exposure permissible and to be as diversified as possible. Our fund does indeed make full use of the permissible offshore limit. This exposure is divided between offshore shares and offshore property giving you not only an offshore exposure but a well-diversified one. The balance of our fund is also well-diversified between interest bearing investments, property and shares.