This article is excerpted from a letter by Pieter Hundersmarck, fund manager at Flagship Asset Management, based in Cape Town, South Africa.
We are sometimes asked about our view on South Africa from an investment perspective. We note that local stocks look optically cheap, and our global portfolios are designed to take advantage of opportunities where we find them.
Our view is that our funds are designed to protect our investors from the vagaries of the local economy as well as the depreciating Rand (which has made South African’s 7% poorer per annum from a global purchasing power perspective for over 25 years). Indeed, one of the establishing principles of Flagship Asset Management is the globalization investment opportunities for our clients. As a recent piece by co-portfolio manager Kyle Wales lays out here, while your day to day life may be tied to South Africa, your investments needn’t – and arguably shouldn’t – be.
In light of current circumstances, we feel the need to elaborate further on this general response. This is in part driven by a disheartening conversation we had with a respected financial advisor who informed us that investing offshore still receives considerable pushback from the local asset management and advisor community. We still see substantial evidence of this ‘home bias’ reflected in official investment statistics, and which is correctly criticized by Kyle’s article, as well as by other authors here and here.
As global managers, we direct the bulk of our research efforts towards finding value across the globe. The US, Europe and Japan constitute over 80% of the value of global stock markets, so we tend to see these markets as our natural hunting grounds.
As an emerging market, South Africa has always formed a small part of the global investment landscape (alongside Brazil, India, Russia and other emerging markets) and as such has always been considered by our global funds as a potential destination for investor capital should opportunities present themselves.
However, value to us means investing where the rewards outweigh the risks, and in a nutshell, the future for South African businesses presents one of the worst risk reward tradeoffs we can find.
We would go one step further and say that we disagree with those that say South Africa is ‘on the brink of’ or ‘peering into’ the economic abyss. Rather, we believe it is already firmly here.
Why do we say this? To begin with, two decades of rising corruption and mismanagement have decimated the local economy to a previously unimaginable extent. The driving engine of economic growth, which includes a successful secondary and tertiary education sector, formal skills development, a supportive regulatory environment, friendliness to capital, and equal opportunity for all workers, are either nonexistent or facing enormous resistance from the government.
More concerningly, it is our view that these factors are deteriorating. India, for example, also falls short on many of these factors, although it’s starting point was lower than South Africa, and there is no denying that India is moving in a far more positive direction than South Africa.
Politically, the situation remains dire. The current President, although a vast improvement on his predecessor, leads a party that has presided over the striking economic and fiscal decline of the past 20 odd years. It is telling to us that Ramaphosa’s election in December 2017 has not in any way altered the trajectory set under the Zuma regime – even prior to the COVID outbreak. Corruption remains unprosecuted, unemployment over 30%, bond yields have risen sharply and the currency has weakened. Efforts by the finance minister to shore up the fiscus have been politically stymied.
Corruption is rampant. Each healthy industry or essential economic activity is being undermined – sometimes almost to the point of extinction – by the sheer weight of opportunistic elements attempting to exact rents from it. There is reasonable suspicion that initiatives such as a ‘new’ state airline, a national health insurance program and a state bank are all seedbeds to enable further rent seeking behavior, continuing a culture of corruption that is now firmly entrenched in the country.
In the recent past, these descriptions of corruption may have raised eyebrows as being dramatic. Now, it’s simply an accepted facet of the SA political landscape. We can draw parallels to the 2014 – 2019 “Lava Jato” of “Operation Car Wash” corruption scandal in Brazil (more on this here), which led us to similar conclusions at the time, although we note that the corruption there was of much smaller scale, and the desire by the government to restore credibility to Brazil was far greater.
One of the first things we as global investors look for in a country (before we allocate capital to it) is respect for the rule of law and respect for the rights of property owners. On both these fronts, we do not see the kind of commitment we’d expect (hope for) from the SA government. On the contrary, due to a hollowed out national prosecuting authority, the government seems incapable of enforcing the rule of law towards those accused gross government negligence. It furthermore remains committed to its policy of land expropriation without compensation.
Add to this high crime rates, poor labour relations and weak macroeconomic policy initiatives, it would appear SA is simply not an investor-friendly environment. As such, we find it difficult to ascertain whether South Africa fulfills our basic investment considerations.
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