Comment on Cabinet reshuffle of 30 March 2017
As investment managers responsible for over R220 billion of South African client funds, we find the move by the President to dismiss respected Finance Minister Pravin Gordhan and his Deputy, Mcebisi Jonas, deeply concerning.
Many global and local investors, as well as international credit ratings agencies and other institutions, including ourselves, set great store in the integrity and capability of the team at National Treasury to implement a sound and responsible fiscal policy and high standards of governance among public enterprises. This has helped to underpin our own investment strategy and confidence in the future of the South African economy. National Treasury is one of the three pillars anchoring the economy, alongside the SA Reserve Bank and independent judiciary.
We see their replacement as undermining market confidence and weakening the future path of our local economy. It creates greater uncertainty – both in financial markets and in the ability of the National Treasury team to strictly implement the latest national budget and carry out much-needed reforms.
Furthermore, this decision increases the probability of a sovereign credit rating downgrade to sub-investment grade level by global rating agencies later this year, which would also have negative longer-term consequences for our financial markets and the broader economy.
SA financial markets – particularly the rand and interest-rate sensitive assets like bonds, financial shares and listed property – are likely to remain under pressure from this uncertainty and the negative surprise created in the short-term, until the new Treasury team is able to instil confidence in their ability to guide the financial affairs of the country.
Impact on Prudential portfolios
The consequences of the latest Cabinet reshuffle are very difficult to predict, also rendering the medium-term impact on our portfolios difficult to forecast. While SA’s macroeconomic conditions had been gradually improving in recent months (with inflation falling, the rand appreciating, growth projections raised slightly and interest rate policy stable), this progress has now been put at risk.
It is important to keep in mind, however, that our risk-conscious investment process leads to well-diversified portfolios of attractively valued assets, characteristics that provide some level of protection against external shocks like this.
Prudential’s multi-asset unit trusts have been overweight in SA government and corporate bonds for some time now, given the good value they offered post Nenegate in December 2015. We have also been overweight listed property, to a lesser extent, for the same reason. These assets have performed very well in recent months, but have come under pressure in the past week amid the rumours of the impending cabinet reshuffle.
In our portfolios that are allowed to hold international assets, we have generally been at, or near, our maximum allowed offshore exposure. These holdings have been negatively impacted as the rand strengthened, but are now acting as a portfolio hedge against these unfortunate political events and resulting sudden rand weakness. This risk mitigation forms a key part of the rationale for exposure to hard currency assets in our multi-asset funds.
Similarly, rand hedge stocks have benefitted from the state of heightened uncertainty, and should continue to do so in the short term. Prudential’s portfolios are overweight stocks like Naspers, British American Tobacco, Exxaro, Sasol, Anglo American and Glencore. Offsetting this to some extent has been the weakness in financial shares, especially banks, in which we do hold positions.
As prudent valuation-based investment managers, we believe there are likely to be opportunities created by the greater uncertainty now prevailing that could allow us to buy assets at attractive valuations. This will benefit clients over the medium term. Having recently reduced our bond exposure as the market rallied, for example, this week’s setback has presented an opportunity to reacquire some of those securities at significantly lower prices. We will continue to take advantage of such opportunities where the risk is appropriate, while always being vigilant in our responsibility to protect our clients’ investments.
We would advise clients not to panic in reaction to these events by switching out of their current portfolios. Any portfolio changes should be carefully assessed with the help of a financial adviser should you believe your circumstances or investment goals have changed. Making sudden changes in response to risk events will inevitably prove to be even more costly.