Getting the best of both worlds
A domestic South African general equity unit trust can offer rand hedge properties – and more. It can be used as a vehicle to achieve long term wealth creation, as it provides the flexibility to position the fund’s exposure towards or away from domestic economic factors affecting the local consumer.
It might seem obvious that a simple approach towards balancing a South African investor’s portfolio would be to put 50% of the funds into an ALSI index fund and 50% into the MSCI World Index. But by doing that, the portfolio will limit its exposure to SA Inc and be overweight in its exposure to rand depreciation, since a large portion of the ALSI is represented by rand hedges.
There are advantages to investing in funds that invest in the JSE.
It is a modern, efficient exchange that facilitates rapid and liquid trading and settlement and allows a number of foreign companies to list their shares in South Africa. In addition the capital growth and dividends from equities are more tax efficient than earning interest from cash or money market investments.
Investing in SA shares is driven by expectations of growth in consumers’ buying power. Growth in employment, coupled with above-inflation wage increases and access to credit, boosts consumers’ spending power. Improved business confidence generally follows an uptick in consumer confidence and tends to trigger new investment. In turn, that grows employment and GDP.
The unintended consequence of growth can be higher inflation, which can dampen consumers’ willingness and ability to spend. Higher core inflation is normally followed by a hike in interest rates which means consumers are less likely to take on more credit and have less to spend on other items. A weaker rand is also negative for consumers as it can lead to higher inflation and interest rate hikes.
When these events occur, it becomes less attractive to invest in shares aligned to SA consumer spending and more attractive to invest in internationally diversified companies.
SA has become very much a service economy where retail, personal services, transport, communication and government spending account for roughly 43% of GDP. Financial services account for another 19%. Globally, currency weakness is generally seen as positive for GDP growth as it tends to incentivise exports and boost domestic production. SA has unfortunately struggled to reap the benefits of a weaker currency because manufacturing contributes a mere 13% of GDP.
Analysing the index
More than half of the shares in the JSE All Share Weighted Index (SWIX) could be regarded as rand hedges compared with about 35% that are more sensitive to SA consumer spending. Another 14% operate in areas that are more defensive and less sensitive to spending cycles. There are also “hybrid” shares that react to both rand depreciation and consumer spending.
The rand hedge component of the market has changed little over the last year other than a slight increase in the weighting of SA consumer sensitive shares.
Interestingly, foreign investors are often keen on high quality SA consumer focused companies and tend to drive up the prices of shares like retail group Clicks.
Companies like Richemont, British American Tobacco, Naspers and Aspen are considered rand hedges. SA-consumer sensitive shares include diversified industrials like Imperial and Bidvest, apparel and furniture retailers like Truworths, Foschini and Lewis, and the banks. Shares that are much less sensitive to movements in the rand and changes in spending patterns include food producers and hospital groups – because even when times are tough, South Africans still have to eat and go to hospital when they are sick.
Being a rand hedge or rate sensitive company is not simply related to where the business primarily operates, but its business model. That requires in-depth understanding of individual companies before investing.
It is important for fund managers to distinguish between the two sets of business drivers and maintain a reasonable amount of differentiation and diversity at opportune times. This allows them to alter the weighting in the portfolio depending on their outlook.
The STANLIB SA Equity fund’s rand hedge exposure is in line with its benchmark, with a tilt towards the resources sector. We expect the health of the consumer in South Africa will improve in the medium term, which motivates our 5% active position towards this segment. The STANLIB Equity fund has an allocation of 37% to shares listed outside South Africa, which naturally gives it a much higher rand hedge component.