One of the key considerations in any asset allocation decision at the moment is the state of South Africa’s economy and government finances. The risk in many people’s minds is that the government will not be able to sustain itself, that growth will collapse, and that this will reflect in local asset prices.
For Citywire + rated Nolan Wapenaar, head of fixed income at Anchor Capital, and manager of the Anchor BCI Flexible Income fund, it is most constructive to view this risk on a continuum.
‘On one side is the high road where everything works. We get growth going and prosperity follows,’ he said. ‘On the other end is basically a failed state, where the government runs out of money. Those are the two extremes, but in between you have other scenarios you have to be aware of because they are realistic, possible outcomes.’
Where are we heading?
The first of those possible ‘in-between’ scenarios is one Wapenaar calls ‘the road to nowhere’.
‘This will arise if South Africa is able to get enough revenue, reduce expenditure and get the economy growing slowly so that we find ourselves in a country that just bumbles along,’ he said. ‘It doesn’t really get any better or worse.
‘The other scenario we have to be aware of is one where we bumble along, but government expenditure eventually exceeds revenue, and the state is forced to approach outside agencies for help. That financial assistance will come along with policy restrictions.’
Each of these scenarios has different signals that will indicate the path on which the country is heading.
What to look out for
‘For the high road, we need to see the government regain the trust of the population and of the private sector for investment and growth,’ said Wapenaar. ‘We need to see pro-growth policies and SOE [state-owned enterprise] reform.
‘On the road to nowhere, you will see the developmental state ideals trump reality. The idea that the government can drive economic growth and investment continues, although government expenditure comes under control to a degree to allow them to maintain the status quo. To see that we need to see a slowing of corruption.’
In a bailout scenario, things may be relatively stable for a time, but ultimately funding SOEs and the development state drains the fiscus. Corruption also remains endemic.
‘A failed state will typically take place where populist solutions take preference in government’s eyes, rather than looking for outside help,’ said Wapenaar. ‘We would see money printing and quantitative easing to finance the government, and the taking of money from pension funds through prescribed assets.’
Where should money go?
Each of those scenarios would necessitate a different asset allocation strategy.
On the high road, investors would want to buy South African equities and bonds, and reduce their offshore exposure to benefit from the country’s revival. On the road to nowhere or in the case of a bailout, investors would want to hold South African income but look for growth assets abroad. And in the case of a failed state, investors don’t want any exposure to South Africa at all.
How then does Wapenaar assess the current situation?
‘Looking at it impartially, what are the pointers for the high road? We have seen tenders for 12,000MW of renewable electricity being tabled. That is a massive step toward fixing energy insecurity and the country.
‘The president is also tabling his national economic development plan in parliament. While the details have not been published, rumours are that this is generally quite positive. It will come down to the details and deadlines, but to the extent that we can put pro-growth policies in place, that will be fantastic.’
The government has also accepted that it has neither the financial capacity nor the expertise to execute an infrastructure programme on its own, and is therefore engaging the private sector.
Those are the most positive signs, but there are other indicators to watch.
‘The prosecution of corruption has started, but not necessarily to the extent we need,’ said Wapenaar. ‘We haven’t yet seen high level arrests.
‘Bailouts of the SOEs also continue to worry us.
‘But the expenditure cuts proposed by the finance ministry look reasonable and achievable. We think the government can actually rein in its finances to at least put us on a sustainable path, if not a good path.’
Policy uncertainty also needs to be cleared up, and as Wapenaar noted, that will take time.
‘In terms of a bailout scenario, our biggest concern is the continued propping up of SOEs,’ said Wapenaar. ‘But what we also note is that government has outright rejected a lot of populist ideas. It has rejected prescribed assets, it has rejected changing the Reserve Bank’s mandate, and it has rejected nationalising the Reserve Bank in the near term.
‘So, a lot of populist ideas that could end in failed stake have been taken off the table,’ he added. ‘There is nothing out there saying that we are going down the failed state route. That’s not to say that five years down the line things don’t change, but we are concentrating on the other three scenarios at the moment.’
Home and away
This helps to establish a reasonable asset allocation.
‘We think the most prudent approach for the next 12 months is to earn your income in Africa, and look for your growth abroad,’ said Wapenaar. ‘Our preferred asset classes are domestic bonds, domestic fixed income, and global equity.
‘Even though global equity has run a lot, we do think there is still upside. It is our preferred asset class from a risk perspective.
‘We are incrementally more bullish and positive on local equity,’ Wapenaar added. ‘But not enough to move it to a positive overweight at this stage.’