The South African political environment took a turn last week.
The changes have had a significant impact on financial markets to date. South Africa relies on foreign capital flows to fund its deficits, and with increasingly likely downgrades of its sovereign debt looming (including last night’s S&P move to junk), further volatility can be expected and further sharp declines in the rand are possible. The importance of the loss of independence of an institution like the Treasury is not something that should be underestimated.
Investors should, however, be very careful not to panic and take steps that could be detrimental to their portfolios in the long run. The political situation is very fluid and if the current political direction is reversed in the months ahead, as some believe it could be, we could be closer to an excellent buying opportunity than the start of the descent.
We also need to acknowledge that we have a global backdrop that is supportive of strong returns from many South African assets, should the political situation stabilise. Commodity prices have recovered sharply over the past year and the drought in the north has been broken. The weak rand has underpinned strong improvements in the trade balance and the tourism sector has been booming. The global economy is also enjoying a period of synchronised growth, an environment that is usually very kind to emerging market GDP growth.
Many commentators have argued that the rand has been strong recently. It is worth noting the rand has only been strong when compared to the levels reached during the panic at the end of 2015. There is a case to be made that the rand remains undervalued on many measures and could strengthen materially in the event of more stable and predictable management of the economy. Similarly, because South African financial markets have been rocked by negative political developments for some time, it needs to be remembered that risk premiums have risen and a lot of the ‘bad’ news is reflected in asset prices.
Follow a disciplined approach and take a balanced view when emotions are running high
In times like these, it is especially important that investors focus on their long-term investment objectives and make decisions that boost the probability of achieving those objectives. Most importantly, take care to avoid the common mistake of selling low and buying high.
At PSG Asset Management, we aim to manage our clients’ money in a consistent and unemotional fashion. Specifically, in times like these, we are very careful to do the following:
1. Stay calm
2. Carefully assess risks
When the facts change, you need to be prepared to change your mind. For example, the attack on the independence of the Treasury has elevated risks in South African financial markets. Should this situation continue, we can expect a higher cost of funding for South African institutions.
3. Ensure our portfolios are diversified
Diversification across currencies, geographies and industries provides very important protection against an unpredictable future.
4. Think long term and do not forecast
We have witnessed a string of inherently unpredictable political events over the past year-and-a-half (Brexit, Trump and Zuma). Constructing a portfolio to match your predictions about future events carries very high risk if you are proven wrong.
5. Value cash
We have always been comfortable to hold high levels of cash in our multi-asset funds. Cash can be very valuable in times of panic.
6. Buy with a margin of safety
Owning assets that we are confident are trading at a discount to an intrinsic value over the long term helps to protect against a permanent loss of capital.
7. Be greedy when others are fearful
We have found that keeping a cool head and buying when others are fearful or panicking has provided the best opportunity to generate the long-term returns that our clients require. We expect the current situation to provide such opportunities.
Shaun le Roux is a fund manager at PSG Asset Management