* S&P downgrade lures yield-hungry investors
* Benchmark bond rallies as investors buy the selloff
* S.African bonds offer yields much higher than EM peers
By Mfuneko Toyana
JOHANNESBURG, Nov 27 (Reuters) - South Africa has plunged deeper into “junk” ratings territory and its fiscal situation is worsening but some investors are undeterred, choosing to buy its bonds cheap and pocket one of highest yield premiums offered in emerging markets.
S&P Global Ratings downgraded South Africa’s local currency debt to sub-investment grade on Friday and pushed the foreign currency debt deeper into “junk” territory, while Moody’s put the country on review for a downgrade.
Although widely expected, the downgrade by S&P sparked a temporary sell-off in bonds. But the move had almost completely reversed by Monday as investors “bought the dip”, with local and offshore fund managers lured by yields approaching 10 percent.
“Many managers are still looking to buy the sell-offs and any volatility because of losing investment grade,” said John Morris, a strategist at Bank of America Merrill Lynch in Johannesburg.
“But when markets calm down they’d like to sell the rallies, but that obviously depends on the strength of the rally.”
The yield on South Africa’s benchmark 2026 bond climbed more than 10 basis points in early trade on Monday following news of the S&P downgrade late on Friday. By midday, however, it had shed 25 basis to its lowest in nearly three weeks at 9.215 percent, driven by renewed interest in the debt by investors chasing the hefty return.
The 10-year bond offers a yield well above equivalent bonds from Indonesia, Romania or Hungary that are similarly rated.
“If the external backdrop stays positive, a 9.5 percent yield is OK. I don’t think there is much downside (to bond prices) from here,” said portfolio manager at BNP Paribas Cristiana de Alessi.
Yields on South Africa’s longer-dated bonds are even more attractive, offering yields north of 10 percent, enough for some investors to ignore the mounting fiscal and political risks that have triggered two downgrades this year by the big rating firms.
“Absolute yields of around 10.25 percent on bonds are obviously attractive in the short term,” said Mokgatla Madisha, head of fixed income at Sanlam Investments, who has 180 billion rand under management. “However we’re looking at the belly of the curve, from R186’s to R213‘s, where yields are a little lower but still very attractive.”
Domestic fund managers like Madisha have been underweight or scaling down their holdings of local bonds, spooked by the political turbulence that has seen President Jacob Zuma fire three finance ministers in as many years.
In 2017 local pension funds cut their holding of government bonds to a five-year low of 26.3 percent of South Africa’s 2.2 trillion rand ($160 billion) of outstanding debt. Non-residents meanwhile hold almost 42 percent of the country’s debt.
South Africa’s capital market ranks beside those of advanced economies in sophistication, allowing government to draw on it for 90 percent of its funding, hence the importance of the local currency rating.
“Demand for high yielding emerging market assets still outweighs domestic factors such as politics, fiscal risks and downgrades,” said Dave Mohr and Izak Odendaal, chief strategists at the country’s biggest money manager, Old Mutual, in a note.
Unlike other big emerging markets like Russia or Turkey, South Africa requires by law that domestic pension and mutual funds invest in government debt as part of their liquidity measures. That allowed the Treasury to up its debt issuance earlier this year to plug a growing fiscal deficit. ($1 = 13.7513 rand)
Additional reporting by Sujata Rao in London; Editing by James Macharia and Catherine Evans