We have identified a short term AAA rated IBRD (aka World Bank) bond denominated in South African rand maturing in October 2012, and are targeting a better than 5.50% yield for our clients.
Corporate Bond linked to the South African Rand
The IBRD has bonds, denominated in the South African rand, which currently have a yield of about 5.5% for 14 months. The better yield and very short maturity of this rand bond, when considered with its extremely strong AAA rating, compares favorably in relationship to other high yield instruments in our Foreign and World Fixed Income holdings, and we consider the most recent flight to the relative safety of the dollar a great opportunity for increasing exposure to the rand currency in our basket of foreign fixed income holdings. We believe the dollar’s longer term weakening trend against many world currencies remains a major concern for investors seeking protection against its devaluation and a further erosion of its buying power, and we view the recent domestic growth concerns to have unduly weakened other global “commodity currencies,” such as the South African rand. The resulting spike in the strength of the dollar appears to have presented an intelligent opportunity to revisit diversification into the South African economy, which continues to show remarkably good growth potential in spite of the recent financial turmoil.
US Debt Woes
After Standard & Poor’s decision to downgrade US Treasuries from their coveted AAA status, investors reacted by buying them in droves in wake of Monday’s market precipitous drop, driving the ten year yield down to 2.34%. Today, it was revealed by the Federal Reserve Board that the recovery of the US economy was “slower than expected” and that it has greater “downside risks” in the future. As a result of this dark assessment, chairman Bernanke pledged extremely low short term interest rates for at least two more years. Never in recent history has the Fed specified how long it intends to keep rates low. While companies now have no need to worry about rising borrowing costs, there appears to be an equal assurance that there will be little to no improvement in economic growth. As if unsure what to make of the Fed’s sobering description, the stock market stuttered, then soared. Not to be outdone, the recently downrated government bonds responded to their own inflows of cash, dropping the yield to below 2.18%. (Would various European sovereigns draw such a stunning enthusiastic investor response to the S&P’s downgrade of their debt, the ECB would undoubtedly be thrilled to step away from the table.)
Even before the Fed’s announcement, Federal Reserve watchers assumed that the Fed would set the stage for another round of monetary stimulus. However, instead of offering anything specific to a QE3, it appears at this time that only a range of “policy tools to promote stronger growth” may have been discussed among the regional bank presidents that promise to continue assessing the economic outlook. Whether or not they can or will pull some new “policy tool” out of their bag of tricks remains to be seen. However, the old “policy tool” (for lack of anything better to call it) that Helicopter Ben brandishes so well is, as you likely know, the printing press.
If by chance it becomes a contest of which fiat currency can be devalued (i.e., printed) quicker without inflicting inordinate inflation damage on its own economy, it’s one that the US is certainly well positioned to win. Perhaps the side effect of a well played game would be the transformation of a 14 trillion dollar gorilla into a 20 pound monkey on the back of the US economy. In any event, in our effort to diversify and protect our client’s assets against the dollar’s continued devaluation, we here at Durig Capital scour the globe in search of sound investments in a basket of global currencies and it is why we have chosen IBRD’s South African very short term rand bond as This Week’s Best Bond.
South Africa Economy
South Africa is a middle-income, emerging market with a rich supply of natural resources; well-developed financial, legal, communications, energy, and transport sectors; a stock exchange that is the 18th largest in the world; and modern infrastructure supporting a relatively efficient distribution of goods to major urban centers throughout the region. South Africa is the economic hub of Sub-Saharan Africa and is one of the world’s largest producers and exporters of gold and platinum. The South African economy benefits from relatively good levels of trade freedom, business freedom, and financial freedom. The regulatory environment encourages competitiveness and flexibility. Continuing integration into global commerce has led to notable increases in productivity.
South Africa’s current government largely follows the same fiscally conservative economic policies of its predecessor, focusing on controlling inflation and attaining a budget surplus. Monetary stability is relatively good, but the government influences prices through regulation, state-owned enterprises, and other support programs by which more than a quarter of South Africa’s population currently receives social grants. However, poverty is widespread, and much of the population is poorly educated and lacks access to infrastructure and services. In the most recent year, total government expenditures, including consumption and transfer payments, held steady at 27.4 percent of GDP.
Growth was robust from 2004 to 2007 as South Africa reaped the benefits of macroeconomic stability and a global commodities boom, but began to slow in the second half of 2007 due to the electricity crisis and the subsequent global financial crisis’ impact on commodity prices and demand. At the end of 2007, South Africa began to experience an electricity crisis. State power supplier Eskom encountered problems with aged plants, necessitating “load-shedding” cuts to residents and businesses in the major cities. While inflation was high, averaging 8.2 percent between 2007 and 2009, it subsided to around 6 percent in 2010. Existing labor regulations are not applied effectively, and the rigid labor market has contributed to persistently high (over 23%) unemployment rates.
South Africa’s financial sector accounts for about 20 percent of GDP, and consolidation has reduced the number of domestic banks to less than 40. Capital markets are well developed and centered around the Johannesburg Securities Exchange, which is one of the world’s 20 largest in terms of market capitalization. Due to its limited exposure to the high-risk securities or the complex instruments that triggered the global financial turmoil, the overall banking system has not been severely affected by the crisis. Reflecting a significant recovery from a real GDP of -1.7% in 2009 and 2.8% in 2010, South Africa’s economy is expected to grow at a rate of 3.6 percent this year, according to a report released by the SA Institute of International Affairs (SAIIA) last week, and GDP is expected to grow at a rate of 4.3 percent in 2012, according to the African Economic Outlook 2011 report.
China overtook the United States in 2009 to become Africa’s main trading partner. It has also become the main destination for South African exports since the middle of 2009 and is the leading source of imports. South Africa became a member of the BRICS – Brazil, Russia, India, China and South Africa – group last December.
About the World Bank
The World Bank is not a “bank” in the common sense, but one of the United Nations’ specialized agencies, and is made up of 184 member countries. These countries are jointly responsible for how the institution is financed and how its money is spent. Along with the rest of the development community, the World Bank centers its efforts on reaching the Millennium Development Goals, agreed to by UN members in 2000 and aimed at sustainable poverty reduction.
The “World Bank” is the name that has come to be used for the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA). Together these organizations provide low-interest loans, interest-free credit, and grants to developing countries. The IBRD raises almost all its money in the world’s financial markets—$13 billion in fiscal 2004. With a AAA credit rating, it issues bonds to raise money and then passes on the low interest rates to its borrowers.
In response to the global crisis, the Bank increased DPL financing to $20.7 billion on average in fiscal 2009 and 2010, up from $6.7 billion a year the previous three years. This exceptional level of funding provided a buffer that allowed countries to continue to protect the poor. Bilateral agencies contributed $4.0 billion in cofinancing; the U.K. Department for International Development ($727 million) and the U.S. Agency for International Development ($591 million) were the largest cofinancers. The three regions that benefited most from cofinancing were Africa ($6.3 billion), South Asia ($2.2 billion), and Latin America and the Caribbean ($990 million).
Risks
The default risk is IBRD’s ability to perform. Given its strong underlying multinational support and AAA rating, as outlined above, it is our opinion that the default risk is extremely minimal relative to the currency risk of the South African rand.
The currency risk could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to South Africa’s economy.
South Africa’s rand has gained nearly 20% against the dollar over the last two years, namely a result of its popular inclusion as a commodity based currency. Daunting economic problems remain from the apartheid era, and the current government is facing growing pressures from special interest groups to use state-owned enterprises to deliver basic services to low-income areas and to increase job growth. The government aims to increase farmland ownership by black South Africans to 30 percent by 2014, and its affirmative-action mandates threaten private property rights. Crime, HIV/AIDS, and high unemployment are ongoing concerns. While acknowledging that every investment vehicle involves varying elements of risk, we believe that the recent strengthening of the US dollar relative to the South African rand represents a very attractive opportunity for initiating or increasing exposure to the rand currency in a good multi-currency global bond portfolio.
Allotments
How can investors participate in South African rand denominated bonds? Achieving an institutional sized yield typically requires an institutional sized bond purchase. To facilitate attaining a more attractive yield, here at Durig Capital we bring together many retail bond buyers into a single much larger institutional sized trade. In this week’s syndicate, we anticipate being able to accommodate purchases as low as $ 5,000 US Dollars should that the level that best fits with your interest. So the answer to the question is simple – contact your Durig professional.
Conclusion
Even a modest US economic recovery plainly remains quite sensitive to other global events. However, we believe that the persistent demand for South Africa’s abundant supply of resources from a global commodities boom will likely result in the continued expansion of their economy, and possibly even a strengthening of the rand currency. Therefore, we view the currency risk of this prominent emerging market as an intelligent opportunity that we have recommend our clients take in their continued effort to diversify away from overweighted US dollar based assets, and it is why we are adding it to our Foreign and World Fixed Income holdings.
Disclosure:
Durig Capital clients may currently own these bonds.
Contact our fixed Income analyst for questions at 971-327-8847.
Durig.com | Investment-Income.net
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