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South Africa: Bond funds go where equities fear to tread

When it comes to picking through the fundamentals of Africa’s most developed economy, “pick your poison” often seems a serviceable operating principle.

Anemic growth, high levels of household debt, an official unemployment rate of 29%, an energy parastatal struggling under the burden of $31 billion in debt and an investment grade credit rating hanging by a thread are all part of South Africa’s current narrative. For prudent investors, the case for reducing exposure to the country seems increasingly watertight.

However, a more nuanced picture emerges when South Africa is viewed through the lens of mutual fund flows and allocations, and through some of the quantitative models derived from these datasets.

What goes up…

Funds dedicated to South Africa have attracted assets over the past few years. The table below shows the total assets under management, in millions USD, of the dedicated South African equity and bond funds tracked by EPFR.

Quants Corner 

Over that same period, those assets have also performed solidly if not spectacularly. The table below shows the average cumulative percentage return of South African bond and equity funds.

Quants Corner 

By way of comparison, the cumulative gains since 4Q15 for all EPFR-tracked Emerging Markets Equity and Bond Funds are 37% and 18% respectively.

…doesn’t always ring true

Fund flows tell a less consistent story. The table below shows cumulative percentage flow into dedicated South African bond and equity funds. Flows into South African Bond Funds have surged while those into their equity counterparts have stagnated.

Quants Corner

This raises two important questions. The first is, “why is South African equity gaining ground when it has clearly lost the support of an important class of investors?” The second is, “Why is that investor class pursuing the South African asset class – debt – that stands to be hit hardest if and when Moody’s lowers the country’s last remaining investment grade rating?”

One question at a time

In this blog we will focus on the first question. Before trying to answer it, we need to look at the signal generated by the flow-based indicator created by Srimurthy et al.[1].

The histogram below shows cumulative fund flow into emerging markets from cross-border equity funds over the trailing four weeks to 20th November. Each emerging market is ranked on four-week flow percentage and assigned to one of five buckets. Currently South Africa falls exactly in the middle of the third (middle) quintile.

Quants Corner

This ranking, which is higher than simple analysis of the raw data might suggest, has raised some eyebrows. But it is consistent with a qualitative trend that EPFR has been following for some time: the decision by diversified fund managers to use South African companies with pan-continental business models as proxies for Africa’s growth story, thereby avoiding the costs and risks that come with exposure to multiple smaller, illiquid markets.

In short, fund managers seeking the most cost efficient way to buy into Africa’s story are providing enough support to offset the cold shoulder South Africa is getting from dedicated country investors, hence its middle-of-the-pack quantitative score.

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