S&P have become the first international ratings agency to downgrade SA Government debt to sub-investment grade (junk). What does this mean for the country and for you, the investor?

Any ratings downgrade is never good for the country. In basic terms, it means that the perceived risk in holding Government debt increases and therefore institutions that are willing to hold such debt will require a higher interest return. So when the SA Government goes to the international capital market to raise a large amount of money for a large infrastructure spend eg a new harbour, then the interest paid to the investor will have to increase to encourage them to purchase the SA Government bond. This in turn means that the Government will have to allocate more of the annual budget to interest payments and less to the provision of housing, education, healthcare etc.

The decision taken by S&P last night has caused the Rand to depreciate against the major currencies and the yield on Government bonds has increased but not by as much as would have been expected. The reason could be two-fold:
1. International investors are waiting to see what happens with regard to President Zuma and whether he will be forced to step down;
2. International investors are waiting to see the outcome of the other two major ratings agencies ie Moodys and Fitch.

At this stage, it seems inevitable that the remaining 2 ratings agencies will downgrade SA Government debt. If Zuma is forced out and his replacement puts competent ministers into the key departments, then the return to investment grade status will be relatively short (18 months to 2 years) . If nothing changes then the period could extend to 5 years.

As an investor, as long as your portfolio has been correctly diversified, then any negative impact should be muted. Financial shares and Government bond holdings will have been hardest hit. Gold shares, commodity shares and dual-listed stocks will all have benefitted from a depreciating Rand. Any direct offshore holding will also have benefitted from a weaker Rand.

For those of you who are invested in any of the Quattro funds, all of our portfolios have been positioned for this potential outcome for the past 3 months. The Quattro Cautious, Quattro Moderate and Quattro Growth portfolios all hold the maximum offshore exposure (as per Reg 28). The equity holdings have also been biased towards dual-listed shares (shares that derive most of their revenue in US$, Euros or GBP but have most of their costs in Rand) and the more conservative companies eg pharmaceuticals and food. The Quattro Worldwide Flexible Fund is currently 98% invested offshore, so the depreciating Rand has been good for fund returns.

You are most probably tired of hearing the cry to remain calm and NOT to make any emotional decisions.  As advisors and asset managers, the advice has not changed. To achieve inflation-beating returns, one must take on a certain amount of risk. We have been through a rough 18 months to 2 years in our market, however South Africans are resilient and we WILL ‘make a plan’. The cycle will turn and investment returns will recover. Stick to the plan and you will be rewarded.

If you are invested in the market remember a thought-provoking quote from Warren Buffett:

“The market is a perfect mechanism for redistributing wealth from the impatient to the patient”.

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