What will happen to the stock exchange if Moody’s downgrades us?

From time to time, Moneyweb sends reader’s questions to Rosebank Wealth Group, as part of their ‘Ask an Advisor’ service offering. Trevor Lee answered the following question posed by a Moneyweb reader.

  • What will happen to the stock exchange if Moody’s does downgrade us?
  • If most of my money is invested in Allen Gray – is it advisable to withdraw our money and keep it as cash before we are downgraded?

First question: What will happen to the stock exchange if Moody’s does downgrade us?
A downgrade would put pressure on international bond investors who require investment-grade ratings, cutting our potential pool of investors. The cost of government borrowing would increase, decreasing the amount of money available for other government spending. Most important, the confidence of investors could take a knock, which could affect the value of our currency. These events might negatively affect domestically-focussed South African businesses, (both listed and unlisted) but ‘rand hedges’ could remain stable.

On the other hand, it is important to remember that both bond and equity markets have been anticipating a cut by Moody’s for months. Market prices slowly adjusted in anticipation of a cut. According to analysis in November 2019, when Moody’s changed their investment outlook the cost of insuring South Africa’s debt for five years using credit-default swaps was already more than double Russia’s, which had a similar rating at Moody’s. SA insurance costs were higher than those of junk-rated Brazil and on a par with Bolivia, Jamaica and Belarus. Among all emerging markets, only junk-rated Turkey, Lebanon and Nigeria paid more than South Africa for 10-year local-currency debt.

A further thought is that analysts remain divided about whether or not Moody’s will downgrade SA after the February budget speech, and if it does, what the impact will be. According to media reports, the most pessimistic estimate that a downgrade could trigger more than R150 billon of outflows, while others say that South African assets may even rise in the aftermath, especially if sentiment toward emerging markets stays strong. An article published by Fin24 highlighted a wide range of expert views from the Bank of America, Bank of New York Mellon, Citigroup, Intellidex, Investec, Rand Merchant Bank and Standard Chartered which highlighted a range of views on the likelihood, timing and consequences of downgrading.

Second question: If most of my money is invested in Allen Gray – is it advisable to withdraw our money and keep it as cash before we are downgraded?
Unfortunately you do not specify the type of products you are invested in via Allan Gray or the mandates of those investment products. If the bulk of your investments are in funds with a ‘balanced’ mandate, (which have the capacity to invest across a range of asset types, depending on the view of the fund manager), you should trust Allan Gray fund managers to take advantage of the volatility and/or change of valuations to make the best investment decisions on your behalf. After all, you are paying them to do just this.

The Allan Gray Balanced Fund is classified as a ‘Multi Asset – High Equity’ fund, which means that the equity portion (including foreign equities) of the fund can range from 0% to 75%. As of December 2019 the asset allocation split of the Allan Gray Balanced Fund, was 69% in equities, with the remaining 31% invested in hedging products, property, bonds and cash. This weighting could become more conservative, if deemed appropriate by Allan Gray managers.

If your fund is classified as a South African equity general funds (the industry body classification category of the Allan Gray Equity Fund) the manager is permitted to have 20% in cash, and a minimum of 80% invested in equities. Further, the fund manager can elect to invest a maximum of 30% of the value of the portfolio offshore, with an additional 10% allowed for investments in Africa outside of South Africa. In addition, fund managers of equity funds can opt to favour companies with higher exposure to the domestic economy or to ‘rand-hedged’ companies that have either customers or investments offshore.

The point is that fund managers have a degree of ‘wiggle room’ to escape the harshest volatility that might come in the wake of a possible downgrade. An additional thought is that while it would be a big decision to withdraw your money and keep it in cash, it would be a bigger decision to decide when to reinvest it.

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