Is now the right time to invest in local assets?
9 Nov, 2022

Is now the right time to invest in local assets?

Adriaan Pask – CIO at PSG Wealth

Looking at the news headlines on load shedding, corruption, labour disputes, damaged infrastructure, unemployment and more, it’s easy to become disheartened about investing in South Africa. However, one has to ask: Are there opportunities in this apparent chaos?

In terms of our investment approach, we try to contextualise all the available opportunities and risks by considering both valuation and the macroeconomic picture.

We also know that the macroeconomic picture has becomes increasingly influential on both opportunities and risks when there are substantial monetary policy changes taking place, as we’ve seen locally and abroad.

Given South Africa’s challenges, investors are looking elsewhere for returns, but as many might have discovered, things are not necessarily any easier in foreign markets.

Developed markets around the world are grappling with rising interest rates and large debt burdens. This means that future growth could be challenging for these markets, because debts will need to be repaid. Economies need to drive growth with the funds they borrow, and if this growth does not happen, the burden will only increase.

Matters become more complicated when monetary policy starts to tighten. Interest rates are raised to combat inflation. Since 2008, governments have aimed to stimulate growth with loose fiscal policy, but this option is no longer available given the current debt burden and high inflation. This pattern underpins the global market route we’ve seen over the last 10 months.

If we turn our attention back to South Africa, our debt-to-GDP number at around 70% is still relatively good compared to what we’ve seen globally. Global debt numbers have escalated significantly since Covid. The United States (US), for example, is heading towards 140% debt-to-GDP and inflation rates are hovering around the 8% mark.

Something to bear in mind is that very few developed market professional investors have ever managed money in an inflationary environment. South African professional investors, on the other hand, are much better equipped to navigate an inflationary environment, given their more regular exposure. This is not the first time that we’ve seen inflation at these levels – and it is unlikely to be the last.

South Africa has also seen a commodity boom over the last few years, which have had positive tailwinds for our economy and fiscus. Our current account is in fantastic shape as a result. Compare this to the US, where the current account has been slipping consistently for a very long time.

What this means is that on a relative basis, the gap between South Africa and the US as an investment destination is less significant than many believe. And from a debt perspective, we’re actually in much better shape.

If we then look at the returns that can be generated from South African assets, one can really start to see the case for investment locally.

It’s quite easy to generate a 6% yield on cash investments in South Africa at the moment, and interest rates are still going up. Our bonds are yielding around 10% to 11%, which is extremely attractive. Valuations on our equities are at single-digit levels, and dividend yields are in excess of 4%.

Importantly, our profit margins are very sound. There’s a high component of commodity-company profitability in there, but our margins are higher than those of US companies at present. The earnings yield from South African companies is almost double what you would receive out of the US on aggregate.

That does not mean that there is no merit in diversifying offshore. It is, however, important to look at individual securities on a risk-adjusted basis.

Developed market return prospects are poorer than they were a decade ago. That being said, the risk of overpaying for offshore assets has started to recede as prices have come down. Importantly, the tide has gone out indiscriminately, which always gives rise to opportunities.

Offshore investment provides South African investors with two key benefits. The first is access to a broader range of investment opportunities, particularly from a return perspective. The second is diversification.

In reality, the diversification benefit overtook the return-prospect benefit in recent times. This has been helpful in that we see opportunities in South Africa, and can diversify successfully by introducing some offshore exposure. This has served our clients well.

Looking ahead through the cycle, we would like to be more assertive in investing offshore, once consensus earnings forecasts and the dollar normalise.

It’s not to say we don’t invest offshore currently – there’s still a significant offshore component in our portfolios. However, there are several risk factors that we are keeping a close eye on.

For example, Europe has significant issues with growth and its bond markets. Italian bonds, in particular, are something that we are keeping a close eye on. In China there’s a lot of growth and policy uncertainty at the moment, which is reflected in the volatility of these markets.

The reality is that all around the globe there are issues. South Africa is not risk-free by any means, but it seems like global risks are starting to become more prominent as interest rates rise. Bearing this in mind, local might indeed be more attractive over the long-term.

ENDS

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