Sentiment towards South Africa is poor. It is tempting to believe that excessive bad news is priced into South African assets, which should deliver attractive returns if reality turns out to be less negative than feared. Unfortunately, we do not believe this is likely.
The fundamentals of the South African economy are deteriorating under the current government. One way to highlight this is to discuss South Africa in the context of variables which we regard as important to any investment, namely cashflow, financial flexibility and management.
Three investment questions to ask are:
- Does South Africa generate sustainable positive cashflow?
- Does South Africa have the financial flexibility to respond to an uncertain future?
- Does the management of South Africa, i.e. the government, have a track record of value creation?
Government debt to GDP provides an answer to the first two questions. A material rise in debt to GDP over a relatively short time period indicates sustained negative cashflow, most likely due to excessive and unproductive government spending. As debt to GDP rises, financial flexibility falls and the government has fewer ‘bullets in the chamber’ to respond to surprises.
South Africa’s government debt to GDP has risen from 26% in 2009 to 51% today. In rand terms, government debt has increased by R1.1 trillion rand over the last 5 years, suggesting the government is spending over R200 billion per year more than it earns. This trend may worsen if government revenue falls short of and expenditure exceeds forecasts following recent political events. This cannot continue indefinitely, and probably for not much longer, without negative economic consequences such as further downgrades, currency weakness and higher borrowing costs.
Government’s track record on value creation is similarly poor. A measure of this, which affects all South Africans is the quality of services provided by the state, such as electricity, education and health – all of which are poor. Those with some accounting understanding should look at Eskom’s balance sheet and cashflow statement to get a sense of the mismanagement. Others can consider that the combined construction cost of Medupi and
Kusile has risen to R295 billion. To put that in context, one could build 22 Sandton Cities, the most highly valued shopping centre on probably the most expensive land in South Africa, for the same price.
South Africans, ourselves included, are often guilty of excessive pessimism. We wish that were true today, but objective measures such as these suggest otherwise. In the midst of these challenges, we remain focused on maximising long-term client wealth.
In the Allan Gray Money Market Fund, we have maximised duration whilst minimising credit risk, within regulatory limits. The steep money market curve allows investors to benefit from attractive yields at the longer end. More than 90% of the Fund is invested in securities issued by the big South African banks and high quality corporates.