Financial Planning
Foreign participation in South African
bonds – being ‘underweight’
is not possible
By Bulent Badsha, fixed income strategist at Momentum Asset Management
ncreased foreign participation has been one of the notable
features of the South African fixed income landscape over the
past few years. Some describe foreign flows as ‘hot’ money
distorting the level of South African yields, while others welcome
the long term boost to liquidity.
I
from 2009 to 2012, the flows have begun to taper off due to lower
appetites for EM local assets. There is a more discriminate
approach to country asset allocations due to South Africa’s
deteriorating fiscal and balance of payments metrics leading to
multiple sovereign ratings downgrades.
In the lead up to the global financial crisis (GFC), foreign holdings
of South African Government Bonds (SAGBs) remained
negligible. However, post-GFC, foreign participation is estimated
to be in the region of 50% of daily trade volumes. The key
differentiating factor has been the strategic increase in
allocation towards emerging market local currency bonds (EM
local) in global assets under management.
The single largest holders of SAGBs
Foreigners are now the single largest category of holders for
SAGBs at the expense of local investors, who deployed cash in
local credit assets instead.
‘Underweight’ not possible
It is difficult for offshore fund managers to hold
an underweight in SAGBs. Offshore
asset managers granted EM local
bond mandates generally have
the funds benchmarked against
the JP Morgan GBI-EM Global
Diversified Index, which comprises
local currency bonds issued by 14
different sovereigns, with country
weightings capped at 10%.
South Africa’s weighting in
the index is 10% and it is
difficult for fund managers
to hold an underweight in
SAGBs as this can be very
punitive with South Africa
having a large index
weight and being a
relatively high yielder. A
South African equal weight
of 10% is a minimum
position. For every US$1
billion inflow into EM local
funds, the SAGB market
automatically receives a
minimum US$100 million
inflow.
Following the significant
inflows into SAGBs seen
28
The appetite for EM local assets and foreign demand for SAGBs
coincided with the deterioration in the South African budget
balance and increased government bond supply. Foreign
investors are involved in the South African Treasury Bill (T-Bill), fixedrate bond (SAGBs), inflation-linked bond (ILBs) and interest rate
derivative markets (IRD).
The increased foreign holdings of SAGBs over the past few years
have sparked concerns that SAGBs are susceptible to wholesale
liquidation by foreign investors.
South Africa’s inclusion in the CITI World Government Bond Index
(WGBI) in 2012 introduced another investor class as funds
benchmarked against this global bond index bought local
bonds. The South African weight is negligible at less than 0.5%, but
the assets benchmarked to the index are significant.
Easy access to EM local bond market
The fact that five of the nine government-appointed primary
dealers (PDs) in government bonds are local divisions of
international investment banks affords foreign investors easy
access to our local bond market.
Primary dealers acknowledge that average foreign investor deal
sizes are generally larger than local ones, boosting liquidity in the
market. Apart from country asset allocation, duration and yield
curve positions, foreign investors also have to make decisions on
their foreign exchange hedge ratio.
Foreigners tend to bring South Africa in line with global market
developments. It would have been hard to justify a South African
bond sell-off in the face of the recent global fixed income bull
market. It is our contention that it is not the foreign flows that drive
our fixed income market, but rather that the flows are the conduit
for pricing our market in line with offshore market developments.