Three investment themes for 2021

Three investment themes for 2021

By Elena Ilkova

RMB Markets Research has identified three themes that have the potential to exert significant influence on the South African investment landscape in 2021:

Global portfolio inflows into EMs

The lower-for-longer theme dominating developed market monetary policy is starting to push investors into a search for yield. Emerging markets will offer relatively better returns and would benefit from a sharp rebound in economic activity. While SA faces numerous domestic challenges, it could still benefit from this trend.

A rising tide lifts all boats

The global economic recovery is well underway, but it will not be a smooth upward trajectory. We expect the global economy to strengthen in 2021 as the pandemic disruptions moderate, aided by the distribution of vaccines (potentially faster in developed markets (DMs), slower in emerging markets (EMs)). According to most predictions, the dominant equity market trend in 2020, the spectacular rise in US equities driven by the FAANGs (Facebook, Amazon, Apple, Netflix and Alphabet), is likely to be replaced by a much broader recovery with a shift towards value stocks. This is supported by expectations of a weaker dollar, strong government-led infrastructure investment in China and Europe and a sharp rebound in EM growth. EM equities can expect a better performance than in 2020, especially in commodity-sensitive markets like South Africa.

Persistently accommodative monetary policy across the world, but particularly in DMs, combined with gargantuan quantitative easing programmes is driving a frantic search for yield among fixed-income investors. This was achieved by investing in high-yield debt in DMs during 2020, but local-currency EM bonds, selectively unhedged, are the leading recommendations for 2021.

The relatively large scale of social support provided to South Africans leaves the country with one of the fastest-growing debt burdens among EM sovereigns. South Africa’s fiscal woes and consequently debt sustainability are significant concerns, prompting both Moody’s and Fitch to downgrade the sovereign’s credit ratings in November 2020. Nevertheless, South Africa’s government debt has been attracting foreign buyers given its relatively high real yield.  

Local fund flows

South African investors have displayed a strong preference for shorter-dated fixed income securities, and the covid-19 crisis led to a stampede into money market funds. How quickly those flows shift into asset classes with better return prospects will depend not only on cyclical global factors, but on changes in sentiment.

Will cash still be king?

The second quarter of 2020, when the pandemic-driven hard lockdown was at its most severe, saw extraordinary investment flows into fixed-income funds (R86bn), especially money market funds (R48bn). The rise in savings during the first wave of the pandemic was precautionary, but also driven by the very limited opportunity to spend on anything besides groceries and healthcare. The flow data for Collective Investment Schemes (CIS) for 3Q20 showed a sharp drop-off in fixed-income fund flows, but not a reversal.

Could the preference for cash and near-cash persist through 2021? The early part of 2021 is unlikely to see a rapid change in sentiment – with the uncertainty around a possible third covid wave before vaccines become widely accessible, the allure of cash is likely to remain. But, it comes at the cost of tolerating lower returns: the South African Reserve Bank cut the repo rate by 300bp to 3.5% in 2020 and maintained rates at that level at the first meeting of 2021, while inflation should creep upward to average 3.8% in 2021.

Ultimately, the search for yield will draw investors’ attention back to the equity market. Upward revisions to earnings expectations are already dominating, reflecting an economy that perhaps was not as severely damaged as initially feared. However, very constrained wage growth, specifically in the public sector, and social transfers that must be scaled back may keep the lid on exuberance in consumption-dependent sectors. Infrastructure-driven recovery in economic growth, though, should make some industrial and bank stocks attractive.

ESG-themed investing and infrastructure

A key component of the SA government’s plan for economic recovery is an infrastructure investment drive that relies on partnerships with the private sector. Combined with increasing environmental, social and governance (ESG) awareness, the infrastructure build offers an opportunity to generate investment returns while simultaneously meeting societal needs.

Ready to go?

Managing investment portfolios with an explicit objective to direct funding towards companies and projects that not only generate adequate financial returns but also have a positive impact on broader society is becoming mainstream. The covid-19 crisis has heightened global awareness of the social factor in ESG but, in South Africa, social impact is not a new theme.

The popularity of sustainability-driven investment opportunities translates into an increasingly wide variety of investment choices offered by asset managers. There is little doubt that institutional demand, particularly from pension funds, will drive growth.

Various regulatory bodies’ recent guidance notices outline the pension fund industry’s requirements for addressing sustainability. Embedding these principles into the investment decision-making processes should further accelerate the development of the policies, procedures and protocols necessary to meet regulatory requirements, including those in Regulation 28 of the Pension Funds Act of 1956 (Reg 28).

South Africa’s Economic Reconstruction and Recovery Plan, announced in October 2020, relies heavily on the development of infrastructure to help drive economic growth. The government’s precarious fiscal position will, however, constrain its ability to fund infrastructure projects directly. Therefore, a partnership with the private sector has become a key focus area, whereby the government creates an enabling environment and government funding is used as a catalyst to attract private investment. Given the long-term nature of most infrastructure projects, there is a natural match between the long-dated cash flows these assets generate and the long-dated liabilities of pension funds. This opens opportunities for investment in fixed-income instruments – both direct lending into specific projects and lending through the listed capital markets in the form of project bonds or dedicated debt infrastructure funds.

The biggest challenge is ensuring a steady pipeline of projects that meet the pension funds’ investment criteria. There is an ongoing discussion on whether amendments to the prudential limits per asset class in Reg 28 are necessary to enable greater investment in infrastructure, although it appears that most investors do not view it as a constraint. However, the need for market development is clear – concentration risk and liquidity are important considerations for investors, but improvement in both will be the natural result of developing a significant pool of infrastructure assets.

Ilkova is Investment Strategist in RMB Markets Research team