Allan Gray Bond Fund

The FTSE/JSE All Bond Index (ALBI) has returned a staggering 26.1% year-on-year to the end of September 2024. As much as the positive post-election market sentiment following the formation of the government of national unity (GNU) has led to this bond rally, the expectation of a pronounced US rate-cutting cycle has also played a role. Most importantly, however, monetising South Africa’s Gold and Foreign Exchange Contingency Reserve Account (GFECRA) has to some degree bailed out the fiscus. Without this, or the printing of rands against the profits implied in South Africa’s foreign exchange reserve balances, the South African government would almost certainly have had to increase the size of its bond auctions this year. By August 2024, the South African Reserve Bank had created and transferred R100bn of GFECRA cash to the government, which subsequently ended the month with only R142bn cash. This means that without GFECRA, the South African government would be running a R7tn economy with only R42bn of spare cash – or the lowest nominal cash balance on record in over 50 years. To contextualise this, R42bn equates to six days’ worth of the government’s annual FY24 spending of R2.37tn. Put differently, R42bn equates to 40 days’ worth of the South African government’s debt-servicing costs (which are estimated at R382bn for FY24).

Without GFECRA, we would have been staring into the abyss, and the supply of government debt would have had to increase materially. The question then remains, with only R25bn of GFECRA left to be monetised in each of 2025 and 2026, will the government be able to live within its means and implement the fiscal reform required to contain the budget deficit? Alternatively, will a South African super-growth cycle materialise? It would appear that year-to-date tax collection has disappointed versus the February 2024 Budget estimates, although some of this under-collection might be offset partially by the tax levied against two-pot retirement fund realisations. We await the Medium-Term Budget Policy Statement for further details on this.

At the end of September, the South African 20-year bond had rallied by a cumulative 260 basis points (bps) from its year-to-date yield high of 13.3% in April down to an intraday yield low print of 10.7% on 30 September. By perusing the JSE’s trade statistics, it appears that local investor participation in South Africa’s government bond auctions in the last quarter has been very low. Most of the fresh cash in the bond market appears to have come from foreigners, but they have not participated in any meaningful size in South African equities yet. The recent yield of 10.7% on the South African 20-year bond is just 50 bps wider than the 10.2% yield recorded at end-February 2020.

One could thus argue that the market is now overvalued when one considers that the South African government’s debt pre-COVID was 56% of GDP versus 75% at present. In the same vein, we were spending as little as 14 cents on every tax rand towards servicing pre-pandemic debt versus 21 cents now – and, in fact, even higher if one includes the Eskom debt relief programme in these debt-servicing costs. When comparing the South African 10-year bond to the US 10-year bond, the spread differential is less than 620 bps, which is the tightest spread on record since 2018 when the South African government’s debt burden was significantly lower than present (and lower than any year in the Budget forecast for 2025-2028).

That said, even if one buys into this argument, it is perhaps important to consider that the market can trade away from fundamentals for extended periods and that optimism around the GNU and higher South African GDP growth may spur foreigners to sink more capital into the market regardless. Fixed capital investment in South Africa, which is a necessary precondition for higher growth, has been contracting for four consecutive quarters. While there are investment projects in the pipeline that should see this rise, their size and pace remain unclear and rest on the speed at which certain reforms can be put through – including those for private concessions along Transnet’s rail and the requisite tariffs and funding for reform to be enacted.

Over the last quarter, the ALBI’s weighted average yield fell to 9.7% while the Fund’s weighted average yield to maturity (gross of fees) stands wider at 10.2%. The Fund reduced its exposure to South African government 20-year bonds as their yield fell below our estimates of fair value.

Commentary contributed by Thalia Petousis