For the past week, South Africa has taken quite the number of blows to the - well, everywhere! It all started last week Tuesday with President Jacob Zuma recalling then Finance Minister Pravin Gordhan from an investor roadshow in London. The move sparked widespread speculation of an imminent cabinet reshuffle, and these fears were evident as the rand depreciated sharply versus most major currencies following the news of Gordhan’s recall.
Despite mounting opposition, President Zuma announced a major cabinet reshuffle late Thursday evening. Zuma wielded the axe, firing Pravin Gordhan as Finance Minister, as well as his deputy Mcebisi Jonas, and replacing Gordhan with former Home Affairs Minister, Malusi Gigaba. As expected, the rand continued its downward spiral, and the capitulation was compounded when rating agency Standard & Poor’s downgraded South Africa to junk status the following Monday.
In a previous article, TOP40 Offshore Exposure Revealed, we showed that the companies within the Top40 Index collectively generate 62% of their earnings in foreign markets. Breaking down the index, we found that there were several good picks that could effectively hedge against rand weakness. We now look at the performance of these companies since the cabinet reshuffle, to see if the rand hedge shares do in fact protect against rand weakness.
The annual returns of the Top40 Index are ranked in ascending order, and the offshore earnings proportions are ranked in descending order. A weighted average of these two gives an investability score: high numbers represent a good 1-year performance and small offshore earnings proportion (expected to underperform after cabinet reshuffle) whereas low numbers represent poor 1-year performance with high offshore earnings proportions (expected to outperform after cabinet reshuffle).
In the next step, we rank the shares in ascending order according to their investability score and plot against their 6-day return (since Gordhan was called from an international roadshow by Zuma). From our analysis, shares with a low investability ranking should have performed well over the past week and low-ranked shares poorly. Figure 1 reflects this, with the lower ranked shares (closer to the left of the chart) having mostly positive returns and the higher ranked shares (closer to the right of the chart) having mostly negative returns.
The outliers came from the healthcare sector (Mediclinic and Netcare), which declined in value despite its lower investability score. The weakness within the sector was largely due to the negative earnings update by Netcare on 30 March 2017, and often weaker earnings from one company could suggest trouble for others in the same sector. The financials with large offshore exposure (Investec Plc and Old Mutual) also declined due to the significant weakness from its SA financial exposure that overshadowed the benefit from a weaker rand. This serves as a reminder that investment decisions should take the underlying fundamentals of a company into account.
Figure 1: Post-Gordhan Returns (Click image to enlarge)
The interactive table in TOP40 Offshore Exposure Revealed indicates that one should have shorted NED and TBS and went long on ITU and GFI. A return over the past 6 days would have been 9.04% if these 4 shares were traded accordingly, which proves that the trade proposal does indeed work and can come in handy with the rand touching the clouds as more political uncertainty creeps closer.
Joani van Wyk
Joani van Wyk joined the asset management team in January 2017, responsible for quantitative research of equities across all industries. Joani completed her degree in Mathematical Science in 2015, as well as an Honours degree in Financial Risk Management in 2016, both at the University of Stellenbosch.