Adam Moir
INSIGHT 12/02/2020

Can South African investors learn from their inspirational rugby team?

Adam Moir Product Specialist

As a proud Englishman, I watched on with both disappointment and admiration during South Africa’s historic Rugby World Cup win back in November last year. Coming into the game, South Africa were written off by the press as underdogs, criticised for their supposed unattractive style of rugby and barely given a chance. How wrong did that turn out to be? They outplayed England in every department and thoroughly deserved to lift the Webb Ellis Cup for a record-equalling third time. Hats off, as painful as it was, it was marvellous to see and Siya Kolisi deserves all the plaudits for leading the team as does the coach, Rassie Erasmus, for making him captain.

I get the sense from many South African investors that they feel like the South African rugby team before the final. The odds are stacked against them. There are a number of headwinds facing South Africa’s economy and it has recently become a focal point for economists, investment strategists, and the financial media. Economic growth is muted, forecast to be 0.8% in 2020 according to the IMF, hampered by more frequent load shedding due to Eskom’s inability to keep the lights on. South Africa’s already precarious Baa3 credit rating hangs in the balance following Moody’s decision to revise its outlook from stable to negative. A downgrade to junk status is therefore very possible. A lot will depend on the content of the 2020 Budget presentation in February, in which Moody’s wants to see a plan to stabilise the country’s growing debt pile and address the risks posed by Eskom and other state-owned enterprises.

A shock to any of South Africa’s three main asset markets (government bonds, equities, or the local currency market), will affect local investors’ portfolio performance in various ways dependent on their asset mix. A downgrade to junk will likely place South African government bonds under pressure given the automatic exclusion from investment grade government bond funds and investors benchmarking to global bond indices. This in turn will likely place ZAR under pressure given that 37% (according to the National Treasury) of South African government bonds are owned by foreign investors. If investor portfolios are biased heavily towards allocations to South African equities, they are at risk from issues specific to South Africa and to a broader EM market sell-off given South Africa is still viewed as an emerging market economy. One does not always need strong economic growth for positive equity performance, but investors will look to see earnings growth in order to achieve any positive uptick in equity performance.

So what can South African-based investors learn from their inspirational rugby team?

One of the key changes made by Erasmus that transformed the South African rugby team was the scrapping of the 30-cap rule. The 30-cap rule prevented South African players who were playing overseas from representing South Africa at international-level unless they had already earnt 30 caps. It was clear to Erasmus that with the ZAR being relatively weak in recent years, South Africa’s best players were naturally drawn to lucrative contracts abroad to maximise their earning capacity in what is a short career for a professional rugby player. By abolishing the rule, Erasmus ensured that he had the best players available to him to improve the chances of the team achieving success.

Regulation 28 makes a similar constraint as the 30-cap rule, permitting only 30% of retirement funds’ assets to be available for investment outside of South Africa. While the aim of this regulation is to ensure that retirement savings are invested in a prudent manner, it can be argued that it is perhaps somewhat restrictive and investors may benefit taking a more global, unconstrained approach similar to Erasmus.

Individual Investors also have a single discretionary allowance of ZAR 1 million per year to invest offshore and up to a further ZAR 10 million per annum with a Tax Clearance Certificate. Any investment denominated away from ZAR assets can provide significant diversification benefits in the event of any domestic or broader market distress event. This is particularly noteworthy if an investor has any potential future offshore liabilities; ZAR has depreciated by approximately 50% vs USD over the last ten years. Exposure to developed market assets can also help improve stability in asset prices and reduce overall portfolio volatility.

Alternative investments can provide further diversification benefits to an investor’s portfolio, and more specifically, qualified investor hedge funds, can take a more unconstrained approach when investing in traditional asset classes. Investors should ask themselves what role they wish hedge funds to play in a portfolio when selecting a particular hedge fund to ensure that their goals are met? All too often we see South African hedge funds being selected as a diversifier by investors that are already heavily invested in South Africa assets. Aurum’s proprietary “Strategy Engine”, which tracks over 4,000 hedge funds and represents $2.9 trillion of the hedge fund industry, confirms that while South African hedge funds have, over the last ten years, on an asset weighted basis outperformed the JSE 40 (8.18% vs 7.35%) with lower volatility (8.30% vs 12.9%), they have done so with a correlation of 0.66. Furthermore, in the 20 worst months for the JSE during this period, South African hedge funds on the same basis were negative in 14 of these and underperformed the JSE in three of them.

Source: Aurum Funds, Bloomberg

The South African hedge fund industry as tracked by Aurum represents approximately $3.2bn (ZAR 48bn) or just over 0.1% of the entire hedge fund industry, and if an investor is willing to take an unconstrained approach, there are plentiful opportunities offshore. That said, with so much choice, manager selection is key. Erasmus started his rugby career as a player in 1994, coincidentally, the same year that Aurum was founded, and it took him 25 years of playing and coaching at the highest level to reach the pinnacle of world rugby. There is no pinnacle to long-term investing, but investors’ outcomes can be improved by ensuring that their assets are managed by portfolio managers with a proven track record in each asset class that they are invested, regardless of where they are based. By doing so, South African investors can challenge the investment equivalent of the 30-cap rule, and hope to improve their chances of success just like South Africa’s World Cup winning rugby team.

 

Data as at 31st December 2019
References to Strategy Engine refer to Aurum’s proprietary Strategy Engine database containing data on over 4,000 hedge funds representing in excess of $2.9 trillion of assets as at December 2019. Information in the database is derived from multiple sources including Aurum’s own research, regulatory filings, public registers and other database providers. See the disclaimer and strategy definition for further details.