For every foreign buyer on the JSE there is an equal and opposite domestic seller. The question therefore is what should make local institutions wish to sell when foreigners are keen to buy? Or, put another way, what would make foreign investors think prices on the JSE were too low (hence the buy decision) and domestic portfolio managers simultaneously think them too high (hence their sale)?
The answer may have something to do with the constraints faced by fund managers. For South African funds these come in the form of regulations limiting their exposure to equities in general. No more than 75% of a retirement fund can be held in equities and not more than 25% of the portfolio can be held abroad. Hence, when share prices run (especially when the rand weakens) they may well exceed these limits and be forced to rebalance their portfolios. Foreign investors, by contrast, are typically underweight exposure to SA and can easily add to SA weights, should they wish to do so.
Chris Holdsworth in his latest October Quantitative Strategy Report for Investec Securities published on 10 October shows how SA institutions, given strong performance by equities both here and abroad, are currently heavily weighted in equities:
He also shows that the SA institutions react to strongly to equities outperforming bonds, as they have done recently by reducing exposure to equities, that is selling equities to buy bonds, as shown below:
Hence they are now likely to be selling equities to them, likely to be buying bonds, at least to some extent, from them and also likely to be gradually repatriating funds from abroad to satisfy the 25% limit.
Holdsworth calculates that should equities outperform bonds by 12% over the next 12 months, SA institutions could sell up to R100bn of equities in rebalancing portfolio switches. If so the large current account deficit and the rand will receive considerable support from inflows into the equity market. A strong rand however improves the case for the bond market by inhibiting any thought of higher short term interest rates. The SA interest plays, property, banks and retailers – that benefit from low interest rates – become particularly attractive when interest rates become more likely to go down rather than up.
Expectations of rand strength (and lower interest rates) is not a consensus view in the market place and so there is clearly room for a rand and interest rate surprise. Any strength in emerging equity markets generally will support both the JSE and the rand and further encourage SA fund managers to reduce exposure to JSE listed securities encouraging foreigners to buy. That the rand is an emerging market equity play is no accident. It is partly also a result of regulation of portfolios.
