South African bonds were in high demand at the close of 2020. What is the opportunity for local private investors?
By almost any measure, 2020 was a stinker. Between the COVID-19 pandemic, the global economic collapse and the widespread social and political disruptions, the year was pretty rotten all round. But in December, just as South Africa was bracing for a deadly second wave of COVID-19 infections, news broke that foreign investors were buying significantly more (R13-billion) South African bonds than they were selling.
Following South Africa’s Moody’s downgrade in March last year, analysts had predicted massive outflows of South African bonds. But by the end of November, that net outflow was barely R65-billion; far lower than the R250-billion those analysts had feared. If anything, there was a renewed appetite for South African bonds.
It’s easy to see why. In August 2020 the yield on a 10-year South African government bond was approximately 9.5%, while the same value for three-month debt was 3.53%. For long-term investors, the former was a tempting number – despite the gloomy atmosphere of the coronavirus pandemic and South Africa’s rating downgrades.
“The search for yield has become increasingly difficult across the globe, amplified by accommodative monetary policy programmes run by governments as a result of the COVID-19 pandemic,” says Robert Enslin, Director of Investment Management at StrategiQ Capital. “After accounting for inflation, South African sovereign bonds rank among the most attractive in the world at present.”
Some investors now believe that, with global interest rates and local inflation both expected to remain low in the medium term, yield may be in short supply and the potential real returns from South African government bonds may be substantial. But Enslin warns that South Africa’s debt trajectory (that is, debt as a percentage of GDP) remains a major concern. “That will ultimately dictate the medium-to-long term attractiveness of South Africa’s government bonds,” he says.
What does all of this mean for a private investor? Enslin suggests taking a step back to see where bonds would typically fall into a balanced, diversified investment strategy. “Bonds have traditionally fulfilled a dual role in a multi-asset portfolio,” he says. “They have provided investors with a form of income and they have served as a ‘natural hedge’ in portfolios due to the negative correlation of bonds with equities. Today, both of these factors have been significantly diminished in developed markets as yields are close to zero, offering very low income rates and less downside protection. One could argue that these roles are however still intact with respect to South African bonds”
South Africa’s case is complex and, in many respects, unique. Yes, yields on the country’s 10- and 20-year bonds were high in late 2020, but within just two months they had fallen by 30 to 50 basis points. And yes, ours is a developing economy; but that doesn’t mean all developing market government bonds are offering the same generous yields.
“Developing nations’ sovereign bonds currently offer very low – and in some cases negative – real yields, forcing investors to increase risk exposures to investment grade or high yielding debt or other asset classes,” says Enslin. “Select emerging market debt does provide relatively more attractive yields, however we would strongly advise clients to fully understand the differing risk profile of emerging market debt before allocating capital to this segment of the market.”
Still, while the post-COVID future remains uncertain and the government grapples with its borrowing costs, South African bonds remain attractive. But rather than trying to “time the market”, it’s wiser to consider where bonds might fit into your personal investment plans.