As a stock market analyst and working with some of the smartest fund managers locally and internationally over the past 25 years, predicting the direction of the Rand has been very difficult. So much so that most fund managers say they don’t consider the direction the Rand may take when making investment decisions. I don’t buy into that. Despite that, the issue is that most local fund managers got the Rand wrong since it spiked out in January 2016 during “Nenegate”. This is the main reason for the investment industry’s poor investment performance over the last two years.
From January 2016, the Rand has strengthened 25% or 13% per annum. Over this period, the JSE All Share Index grew 15% p.a. However, the average balanced unit trust fund only grew 6.5% p.a. This is well below its 15-year, long-term average of 12% p.a. while the JSE grew 16% p.a.
This shows the clear disconnect between balanced fund (multi-asset) returns and equity returns over the last two years and it can only be attributable to the strengthening Rand that most fund managers have been on the wrong side of.
Of the large “well known” balanced funds, most have held a maximum 25% direct offshore investment. In addition to this, half their local equity investments are Rand-hedge shares, resulting in approximately 50% of investments in balanced fund unit trusts having an offshore exposure.
There are many reasons to justify this large 50% offshore exposure (25% direct and 25% indirect) but the bottom line is that managers got the Rand call wrong as it strengthened 25% over the last two years and consequently their poor performance.
These mistakes happen, and as I mentioned in the first paragraph, forecasting the Rand has traditionally been very difficult. However, the current issue is how unit trust fund managers will position their portfolios if the Rand continues to strengthen this year and next.
Forecasting the Rand
There are many factors that influence the value and movement of the Rand. Human emotions and perceptions are probably the biggest factors in the short term. This is illustrated by the Rand’s roller-coaster ride over the last 20 years, or in the medium term where the Rand depreciated 50% in the two years up to January 2016 (Nenegate) and then strengthened 25% over the last two years.
In our opinion, the best fundamental value of the Rand is derived using Purchasing Power Parity (PPP). Please see the graph below, supplied by Prescient Investment Managers. The graph shows that the PPP of the Rand/Dollar is currently 11.50, represented by the solid blue line. The red line is the actual spot price of the Rand/Dollar. The difference between the PPP Rand value and the spot price is commonly referred to as the ‘sovereign risk’ in the Rand, which is driven by the political stability and the outlook for the country.
The graph shows how the spot price moved away from the PPP value from 2010 as President Zuma’s politics disrupted the country. This gap has narrowed with a potentially more positive political future with the pending Presidency of Cyril Ramaphosa.
The country’s economic future looks far more positive with Ramaphosa and meaningful change can take place with basic policy adjustments. The country’s economy has been so suppressed over the last nine years that any positivity should boost consumer and business confidence, which should add to meaningful growth off a very low base.
Ramaphosa has started off well with the replacement of the Eskom board and preparing for the recalling of Zuma. With cabinet and economic policy changes likely by the budget in February, it is possible that Moody’s will give us another reprieve and not downgrade our debt rating. This will all bode well for the currency and should support further strength this year to below 12 to the US Dollar.
Among other factors affecting the Rand is the continued flow of global funds to emerging markets as global synchronised economic growth continues. This also supports firmer commodity prices which traditionally has boosted the Rand’s value.
Lastly, if the Rand continues strengthening, the flow of funds from offshore investments back to local should provide a meaningful underpin.
Conclusion
Over the last two years we have consistently forecast a stronger Rand with our last report on 19 December (Rand/Dollar 12.72) predicting the Rand to be below 12 to the Dollar in 2018. We have positioned our portfolios to have a far lower than average offshore weighting, which has minimised currency-related losses with much lower risk.
Our recommended portfolios are well positioned to benefit from a strengthening Rand and we will make the necessary risk adjustments as political and economic uncertainties reduce.