South African debt downgraded to ‘junk’ status
What happened?
Last week saw S&P and Fitch, two credit ratings agencies responsible for evaluating the credit-worthiness of borrowers and related debt, downgrade the rating of South African Government debt to a status of below investment grade or ‘junk’. This downgrade resulted in a consequential downgrading of South African parastatals and banks. The decision to increase the risk rating of South African debt was largely based on political concerns following the firing of Finance Minister Pravin Gordhan and the apparent shift towards populist policies by the government.
Why does it matter?
The global investment community relies on the credit ratings agencies to evaluate the riskiness of lending borrowers money – the riskier a borrower’s ranking, the higher the interest rate demanded.
In effect this raises the cost of debt financing for the South African government, which limits the country’s ability to affect economic growth in the future. It also has ramifications for the cost of financing for individuals and corporates in the country, as well as driving inflation higher.
Finally, it limits the ability of certain types of international investors (e.g. Pension Funds) from holding South African issued bonds (debt). Another downgrade to our debt could potentially force these investors to sell our Bonds, causing a drop in their price and Rand weakness as these investors’ funds exit our markets.
What is the market impact?
Since markets are based on expectations of economic activity, negative political and economic developments are expected to have a negative impact on investment markets and our currency. To date the impact remains relatively mild. While surprising, it is likely due to a combination of other developments globally (e.g. US attack on Syria) as well as ‘wait-and-see’ approach being adopted by some in the international investment community. As stated in our previous communication at the end of March, market volatility is likely to continue over the short term given this uncertainty.
How will this affect my investments?
Over the two week period, the GTC Investments have held up well, avoiding negative returns and outperforming their respective investment markets.
In the event of a further downgrade and subsequent disinvestment from foreign investors, we would anticipate some drawdown in the Bond markets, and a corresponding negative impact on Financials on the stock exchange. These negatives would be offset to a degree by gains in Rand hedge shares and offshore investments. Critically these would all be short term movements and as we have seen over the recent turmoil, the well diversified nature of our investment strategy would ensure the portfolios continue to ride out the volatility admirably.
As noted previously, any short term volatility is unlikely to have significant negative consequence on our clients’ long term investment objectives.
What action has GTC Investment Analytics taken?
GTC Investment Analytics will continue to manage the investments in a consistent manner, maintaining our focus on the delivery of long term investment returns generated within a diversified risk controlled structure.
What action do I, as an investor, need to be taking?
Given the diversified nature of the portfolios, as well as the ongoing manner in which GTC continues to manage them, the short answer is that no action is currently required from investors.
If your circumstances have changed, or if you feel it may be time to revisit your risk and return objectives, please contact your GTC consultant. However, as we continue to reiterate, we do not recommend making significant or structural changes to investment portfolios based primarily on short term market movements.
Clive Eggers
Head – Investment Analytics
