With all the bad press around SA, following the July unrest and ongoing concerns surrounding corruption and its effect on the economy, it may be surprising to many that South African asset managers are currently fairly positive on most local asset classes. These findings follow a series of due diligence meetings with some 50 local asset managers covering equities, property, fixed income, and private equity carried out in July as part of investment firm RisCura’s ongoing manager research and selection process.
This viewpoint reflects a fairly material change in sentiment when compared to a few years ago when most managers favoured both offshore assets and exposure or at least local counters with large offshore exposure.
The overall sense is that, after several years of disappointing performance, SA assets are not only cheap, both in absolute and in relative terms (versus their own histories as well as versus other emerging market peers) but that there are also some other tailwinds further supporting the ‘buy local’ theme.
Tailwinds supporting local assets
The single largest support to local equities is the very low level of local interest rates — now at 50-year lows — not only because that makes all other competing asset classes relatively more appealing, but also because it lowers the discount rate applied to cashflows/earnings, thereby raising their value. And with local interest rates expected to remain low for some time owing to the weak local economy (Covid-19 lockdown-induced, along with the other well-known growth constraints), along with low inflation, that support is expected to be around for a while longer.
The above, combined with the low base off which local assets are coming, assists too, whether that is about earnings (now rising sharply) or the low level of investor interest, especially foreign interest. Foreigners have been net sellers of South African equities since November 2018, on a cumulative one-year basis in the amount of R124 billion; that is SA assets are arguably both under-owned and cheap in that they trade at their lowest forward Price/Earnings (PE) multiple in 12 years. The above helps to explain the local market’s resilience to the many local concerns and challenges. And then, South Africa is also benefitting from the strong current flows into emerging markets, more generally, and into commodity-producing ones, more specifically.
As such, the local currency has strengthened, tax revenues have been far higher than budgeted (due to the very strong commodity cycle and its impact on resource company earnings), and SA has had a welcome reprieve, from what might otherwise have looked like a precipice. These tailwinds will, however, not last forever, and it is thus critical that SA makes much further and faster progress to structural reforms, especially around economic growth, and job creation.
Whilst the more bullish tone is welcome, it is important to recognise that SA capital markets have recovered substantially off the distorted Covid-19-induced sell-off in the first six months of 2020. This is similar to what many other global markets experienced, yet again somewhat surprising considering just how negative the Covid-19 pandemic and related lockdowns were, along with the very slow pace of vaccine rollouts. As such, for South Africa and capital markets more generally, the ‘easy (post-Covid-19) money’ has already been made.
The managers we spoke to also expressed some concerns around the potential for higher levels of volatility going forward, especially if inflation numbers in the US and other developed markets prove not to be ‘transitory’ and with that, the risk of rising interest rates, especially in the US.
Responsible investment practices
A key focus of all manager research meetings is increasingly responsible investing, that is, in the critically important area of Environmental, Social and Governance (ESG). An escalating range of approaches is now being adopted by managers, as they are being questioned about their approach, in an ever-growing level of detail, whether by clients or investment consultants. This area is now very much ‘top of mind’ for all, which was not the case just five or so years ago.
As a result, managers have formulated a response to the questions raised on this topic as no manager can afford to ignore or underplay ESG anymore. It is now far harder – yet ever more necessary, for all asset allocators to assess, score and evaluate the various ESG approaches taken, particularly with the increasing risk of green-washing, that is pretending to be ‘ESG compliant’, when that is not actually the case. This level of introspection and due diligence is far easier said than done.
The approaches taken tended to vary widely, often based on factors such as whether the asset class is listed or unlisted; the size of assets being managed; and the size of the team and resource available to the managers, among others.
Often smaller managers assume an approach of either exiting or avoiding a position that fails their ESG screen, rather than engaging with the underlying company. The reason for this is that smaller managers either don’t have the internal resources to engage fully or feel that their holdings are too small to provide them with sufficient ‘negotiating power’ with the underlying corporate. This plays to a potential advantage that smaller managers have in being nimbler and faster in execution than their larger counterparts.
The larger managers, in contrast, almost always took the opposite approach, that is favouring engagement rather than exclusion. This is because they either believe that is the ‘right thing to do’ and have the resources to be able to do so, or perhaps slightly more cynically, that they cannot afford a further reduction in the already diminishing local universe of available counters.
We will be watching this space very closely and interrogating managers accordingly going forward.
– Glenn Silverman
Investment Strategist, RisCura