FOREIGN CAPITAL

SA vulnerable to foreign capital flow reversals

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The International Monetary Fund (IMF) report on South Africa, released in
October 2013, discussed the country's prevailing economic situation and its
future prospects. Although the report's findings were wide ranging, an
observation of particular relevance to South Africa and our current
investment climate was the IMF's concern relating to our vulnerability to
foreign capital flow reversals.

The concern stems primarily from three interrelated issues:

1.     SA's high current account deficit

The report highlights that at 6.8% of GDP South Africa has one of the highest current account deficits amongst all emerging markets. 

2.     A risky funding mix

To a large extent, the current account deficit has been funded by foreign
portfolio inflows which are notoriously fickle in nature. Foreign ownership
of SA listed equities and government bonds currently stand at 34% and 36%
respectively. Given the capricious nature of this type of investment,
inflows can swiftly switch to outflows.

3.     The liquidity of the country's financial markets

SA has the biggest and most liquid stock exchange in Africa. 

Consequently, if foreigner investors decide to sell SA bonds and equities
this process can take place quickly, leaving the country short of the
capital required to maintain its current level of expenditure.

Since the beginning of 2014 this risk has turned into a reality, exposing
South Africa's economic vulnerabilities. For the year to date, foreigners
have sold approximately R27 billion's worth of SA government bonds,
resulting in higher yields and a depreciating currency. 

The catalyst for the reversal in capital flows has been the "tapering" of
quantitative easing (QE)in the US. It is now widely anticipated that QE will
be concluded by the end of the year and that interest rates in the first
world will begin to rise in 2015. In this environment, SA's ability to
attract foreign capital is likely to remain under pressure, suggesting that
bond yields will continue to rise and that the exchange rate will remain
weak. 

With volatility set to continue in local markets, the importance of
diversification when constructing an investment portfolio is highlighted.
Diversification across investment types and across economies helps increase
certainty of outcome, as the impact of unexpected market events is reduced. 

In addition to diversification benefits, first world markets are currently
offering investors good value. Based on current valuations it is possible to
invest in some of the largest and most recognisable companies in the world
on dividend yields in the region of a healthy 3-4%. With economic growth
prospects steadily improving in these regions and taking into consideration
the rand's vulnerability to a slowdown in foreign capital inflows, the
investment case for offshore equities remains compelling.

Retired investors are likely to benefit from higher bond and property yields
in the future however, while Bond and property yields are rising, investors
will experience capital loss and hence should avoid these asset classes.
Investors will be best served by investing in companies that are able to
grow their earnings and dividends in challenging economic conditions. For
Retired investors holding a portion of their investments in cash, they are
likely to benefit from rising interest rates in SA.

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