PSG Asset Management has warned that the combination of public debt that is fast approaching 80% of GDP and low economic growth projections might see investors question whether government bonds remain a sound investment.
However, Lyle Sankar, head of fixed income at the asset manager, said the group’s outlook for SA government bonds doesn’t rely on economic growth outperforming expectations.
“Pricing in some of the most bearish sentiment we’ve experienced towards SA assets, the average SA bond now offers a yield of 11.5%. That yield implies that SA will either face a debt crisis, or inflation will be well in excess of the upper end of the Reserve Bank’s target band (6%). Considering the metrics, we don’t believe a debt crisis is likely over the medium term,” he said.
“SA has a very well-structured debt profile with only around 12% of long-dated bonds maturing over the next four years. If a debt crisis is a low-probability scenario and inflation averages 5% to 5.5%, investors who buy these government bonds at an average yield of 11.5% today will earn inflation plus 6% to 6.5%, which is similar to long-term real equity returns,” Sankar added.
The steepening of the curve on government bonds reflects investor concerns about the fiscal risks that may emanate from above-inflation wage settlements, weakening domestic growth prospects, lower revenues from weaker commodity prices and export volumes, among other concerns.
The likes of PSG have stepped in to fill the void left by foreign investors who have been selling government bonds over the past five years.
In its latest Financial Stability Review, the Reserve Bank warned that local investors may be unable to fill the gap left by foreigners withdrawing as the economy weakens due to constant power cuts.
The central bank has described the sharp sell-off by offshore investors as “a significant structural shift”.
The bank’s data shows that since November 2022 local financial institutions, excluding banks, have significantly increased their holdings of SA government bonds. Domestic unit trusts accumulated almost half of the R73.26bn of SA sovereign debt issued in the past six months, while pension funds gobbled up 21% and long-term insurers 10%.
Business Day reported on Wednesday that Victor Mphaphuli, head of fixed income at Stanlib said there in still appetite in the local investor community to buy government bonds.
Sankar said that with US yields are five times higher than during the global financial crisis of 2007-08, investors are considering the prudence of pursuing offshore fixed income assets.
“While we do see and use the diversification benefits of offshore assets, we would be cautious of a strong risk appetite for these markets. Investors make a critical call when shifting assets offshore as we have seen in the past year — both on the valuations of the assets they buy as well as on the currency risk,” he said.
“Developed market bonds in our view offer significant risk of capital losses as key markets (the US, the UK and Japan) continue to run budget deficits against significant debt maturities. The US has approximately 46% of its debt maturing in the next four years. This creates a cocktail of significant bond issuance at a time when yields are five times higher than recent years, producing a spiral of interest costs.”
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