Have you got one eye on the political and economic news and the other on your investments? Feeling nervous? After all, whatever form your nest egg takes, if the assets are local, you’re essentially investing in the South African economy.
Simon Brown is the keynote speaker at the IFSA Prosperity Roadshow in George in May 2022. For more of his insights, you can sign up to join this free investor event.
Macroeconomic fundamentals: If SA sneezes, will your investment catch cold?
There’s a very real sense that the world is in a state of upheaval. We’re only just (hopefully) emerging from a pandemic, war has broken out in Ukraine, extensive sanctions have made Russia an economic pariah and interest rates are rising.
South Africa, GDP and the growth question
After contracting by 6.4 percent in 2020, South Africa’s GDP grew by 4.9 percent in 2021. This strong uptick from a low base was aided by tailwinds from a favourable global climate. Even so, the South African economy is still smaller than before the pandemic.
Eskom remains the biggest drag on economic growth. Other aggravating factors include the July riots and Transnet cyberattack together with the familiar scourges of poor service delivery, policy inertia and strike action.
In tandem with the more muted global outlook in 2022, these stubborn bugbears look likely to keep GDP at roughly two percent. But for investors, this is not the final word on your growth prospects, as Brown explains:
“Good managers, good companies, good businesses in good areas can markedly outperform the economy and their competitors.”
Interest rates and the debt threat
The SA Reserve Bank’s Monetary Policy Committee has announced its intention to normalise rates to pre-pandemic levels. In line with this policy, we’ve seen three hikes since rates bottomed out.
In the context of the South African economy, levelling out at prime of 8.5 or 9 percent is not particularly dramatic. Of course, with household debt levels at historic highs for the country, the increased cost of credit is going to leave many consumers feeling the pinch.
For a number of market observers, including Brown, the bigger concern is inflation.
What inflation has to do with the price of eggs and more besides
Thanks to the sharp upturn in economic activity and supply bottlenecks in 2021, inflation has reared its head once more. Inflationary pressure translates into higher input costs for businesses, which can squeeze profits. For this reason, it has also correlated with lower returns on equities in the past.
Brown indicates that before the outbreak of war in Ukraine, it looked likely that inflation would peak at 5.5 or 6 percent before trending lower again. Now, with sanctions on Russia creating oil and gas shortages and Ukraine’s production of crops – such as sunflowers – decimated, food and energy inflation are very much a reality.
Because commodity prices – and not just for oil – are set on the global market, the fact that we produce enough sunflowers of our own won’t protect us from price increases.
Potential silver linings for the South African economy
But it’s not all doom and gloom when it comes to investing. South Africa has recently enjoyed a mineral resources boom that has given the economy a lift, according to Brown:
“Suddenly, through sheer luck, we’re in quite a sweet spot as an economy. In the last two years, we have had over R300 billion extra revenue in the budget – equal to the gain in tax collection if the government increased VAT by six percent.”
Previously, it seemed that the best years of this bullish period might already be behind us. But sanctions on Russia are likely to change that. With their mining sectors blocked from accessing global markets, resource prices could remain high.
If the finance minister sticks to textbook economic practice and uses the windfall to pay off debt, we could clear Eskom’s books in around two years and half of the national debt.
Sentiment and volatility: Mood swings and roundabouts
That’s reason to feel optimistic. But faced with government’s inability to stimulate stronger economic growth and turn around SOEs, Brown says that local sentiment around investing in the South African economy remains negative.
Since broad-based private-sector investment has traditionally served as the engine for economic growth in South Africa, improvement in the RMB/BER Business Confidence Index – arguably the best indicator for private-sector investment appetite – has the potential to shift the needle on our fortunes.
Despite a recovery from a historic low of five percent in mid-2020, current levels of around 46 percent are still a far cry from the 80 percent reached in the first quarter of 2007 before the financial crisis hit.
Considering the tumultuous times and systemic issues within the South African economy, where should smart investors looking to diversify their portfolio put their money?
Why private equity, why now?
Although both listed and unlisted companies are subject to the same broad macro-economic conditions, private equity is not exposed to the same fluctuations in investor sentiment and stock price volatility that characterise publicly traded markets.
That said, private equity markets are cyclical and, as we emerge from the pandemic, now may be the best time to enter.
Diversify to spread risk
Unlike overseas, private equity tends to be largely underrepresented in South African pension and individuals’ portfolios. That alone makes this alternative investment a great way to diversify.
There is also a global decline in new listings that is at least partly attributed to the increasing availability of private equity. South Africa is no different, as JSE CEO Leila Fourie explained, defending the slide in listings.
As a result, companies tend to delay IPOs.
To catch the upward growth of promising new businesses that have moved out of the start-up phase, private equity is the ideal vehicle.
Bear in mind that private equity is relatively illiquid, so you can’t cash in at short notice. It takes time (five to seven years) for fund managers to make meaningful changes and generate value. That means long-term investment horizons.
Fund managers – gatekeepers
In addition to the undeniable importance of diversification, the bar is often much higher for private companies than those that list to obtain capital.
To quote Brown: “Listing on the JSE literally requires ticking some boxes – and I’m not disparaging the JSE … And that’s best illustrated by Iqbal Survé’s AEEI down in the Cape and of course the Guptas and their uranium mine. With PE, neither of those two businesses would have passed muster.”
Why? Because private equity fund managers act as limited partners in investment companies and sit on their boards. Aside from fundraising, they’re to a large extent responsible for turning the business around or scaling it. To ensure a company has the potential to deliver increased value, fund managers take a careful look under the hood.
This hands-on approach to driving growth means fund managers’ reputations are on the line. What’s more, many fund managers – including IFSA – invest alongside their clients. For these reasons, robust private equity track record is a strong indicator of future performance.
More than just financial returns
Private equity is also an excellent choice for impact investors who not only want their money to generate financial but also environmental, social and governance (ESG) returns.
The 2021 Southern African Venture Capital and Private Equity Association (SAVCA) survey reveals that 96 percent of PE firms consider ESG when making an investment decision. What’s more, 72 percent of PE firms intend to escalate efforts to manage and track the ESG performance of portfolio companies over the next 12 months.
At IFSA, we understand that finance and investing is not so much about the numbers (although you can read those in our fund sheet) as the people. That means making every effort to connect with and understand both the individuals who are building companies and those who invest in them.
Get in touch – we can help you diversify
Are you looking to diversify your portfolio based in the South African economy and avoid volatility in turbulent times? We’d love to get to know you. Because we believe prosperity is built on relationships. To start forging a truly rewarding one, contact us for a free personal consultation.
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