Picture: REUTERS
Picture: REUTERS

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GOVERNMENT bonds are already reflecting SA’s sovereign debt at junk-status prices, asset managers and analysts say, which means it is possible not much will change in the domestic bond market if or when debt rating agencies downgrade their assessments.

Moody’s arrived in SA on Wednesday to review the sovereign debt rating, after it put SA on notice for a downgrade on March 9. Finance Minister Pravin Gordhan and senior officials will have to convince Moody’s the government has some concrete plans to avert such a step.

Until recently, Moody’s had been the most upbeat among rating agencies about SA, but it said last week it would downgrade if it were not convinced debt could be managed, or found evidence of "further shocks" to economic growth.

PSG Asset Management’s head of fixed income, Ian Scott, says the bad news in the markets has been factored into the yields of fixed-income assets, such as bonds.

The risks to bond investors have been accounted for — possibly over accounted for — and risks of incurring capital losses are low. There are opportunities for savers, investors, pension funds and corporations to benefit from bonds by investing in apt unit trusts, he says.

South African government bonds are reflecting a price of junk status, and a downgrade to junk does not necessarily mean debt default, he says. PSG Asset Management, which had no government bonds in its portfolios three years ago, is adding to its bond positions.

IG’s market analyst Shaun Murison says a subinvestment-grade rating is already being priced into domestic bonds.

It will perhaps be more surprising if SA were able to avert a move to junk status following the rating reviews scheduled for June, he says.

As global markets continue recovering from a recent sharp correction, listed property and domestic bonds have been the two best asset classes in terms of total return.

The South African all-bond index was in front last Monday, with a return of 6.1% this year, followed by the South African listed property index’s 5.1% gain. After that, comes the all-share index’s 2.3% growth, while cash has returned 1.3%.

However, by Friday, the property index had overtaken the bond index, with property returning 7% year to date and the bond index 6%. The all-share index provided growth of 5.3%, and cash returned 1.4%.

B onds and property are recovering from serious hits in December after Nenegate, when the all-bond index lost 6.7% in December alone and the South African listed property index lost 6.1%.

Since its low on January 21, the South African listed property index has shot up 13.8%, while the all-share index is up 12.3%, says Stanlib director of retail investing, Paul Hansen.

Foreign investors continued to buy South African bonds last week, to the tune of a net R3.97bn, but sold net equities of R2.5bn. For the year to date, they have bought a net R7.9bn of South African bonds, but sold a net R13.4bn local equities.

But Coronation Fund Managers head of fixed interest research Nishan Maharaj says an asset class should not be pursued because it is outperforming others. "Current performance says nothing about the possibility of future gains and losses," he says.

Bonds have fared well since the beginning of the year, but the all-bond index was down 3.9% last year, with the all share, property, and cash up 5.1%, 8%, and 6.1% respectively, says Mr Maharaj.

ETM Analytics’ financial market economist, Ricardo da Camara, says bonds offer protection against the risk of a general equity market correction, which seems more likely, given the growth pressures faced by the South African economy.

Junk-grade risk remains roughly as much in play as it was before the 2016 budget.

"Although the market has moved to price in this event risk, there always tends to be a knee-jerk reaction in the market, and we may well see bonds weakening further in the wake of a downgrade," he says.

Junk-rating risk lies with Standard & Poor’s (S&P), given its negative outlook on its BBB-rating, compared to Fitch with a stable outlook. This implies S&P is more likely to give SA a sub investment-grade rating, while Fitch may change its outlook to negative ahead of a move into junk. Moody’s rating is two notches above junk, says Mr Da Camara.

This is crucial as SA’s average rating will still be investment grade even if S&P cuts SA’s rating in June or December, while more downgrades by Fitch or Moody’s may follow only a few months later, he says. A bond is an interest-bearing debt instrument issued by governments as part of their budget-funding sources, and issued by local authorities, such as municipalities, parastatals and companies.

Bonds issued by the central government are often called gilts. Bond issuers pay interest, called the coupon, to the bondholder every six months. The price/value of a bond has an inverse relationship to the prevailing interest rate, so if the interest rate goes up, the value goes down, and vice versa.