As South Africa’s medium term outlook has deteriorated, many investors have become increasingly vocal about having higher exposure to rand hedges. But does the available pool of locally listed rand hedges allow for a consistent and successful rand protection strategy? Historical returns and correlations do not seem suggest so.
The past decade has been particularly difficult for local equities, with many investors becoming skeptical of South Africa’s medium term prospects. Locally sensitive sectors, such as retailers, financials and general industrials in particular, have borne the brunt of a deteriorating macro environment. Only a handful of “SA Inc” stocks have done well by taking advantage of regulations, innovating and exploiting opportunities that have emerged from government’s failures to implement policy (e.g. energy, logistics, schooling).
Rand hedges, which are companies whose earnings are linked or denominated in hard currency and thus “protected” from adverse rand movements, have fared much better. As investors have become more bearish of South Africa’s outlook and by implication the trajectory of the rand, many have become increasingly vocal about having higher exposure to rand hedges in their local funds.
But does the available pool of locally listed rand hedges allow for a consistent and successful rand protection strategy? Historical returns and correlations do not seem suggest so.
Opportunity set and historical performance
The availability of rand hedges in the local market is limited and in the Top40 universe, excluding resources, there are less than ten stocks that are plausible candidates (highlighted in blue in Chart 6).
Over the past 5 years, the rand has depreciated annually against the US dollar by 4.8% and against the euro by 3.3%. This should have been a significant tailwind for these stocks, particularly when we consider that the JSE All Share Index, over the same period, has returned 9.8% per annum. However, with the exception of the resource index, Richemont and Naspers, which have fared well over this period, returns in rands have been mixed and not particularly impressive for half of the non-resource set of stocks, which also come short of beating a US dollar cash index and thus “hedging” the rand.
Chart 6: 5-Year returns, annualised (rands) (to 31 October 2023)
Source: Bloomberg, Northstar AM – Rand hedges are highlighted in Blue
Furthermore, when we consider the performance of these stocks against global indices, the outcome is also not particularly different with only Richemont outperforming the MSCI World Index in US dollar terms. Whilst we are not debating whether rand hedges should be competitive against their global indices, it is also worth noting that all charted stocks in chart 6 have underperformed their respective MSCI global peers groups in US dollars over 5 years.
Rand correlation – Do rand hedges do their job?
While rand hedges benefit, in rand terms, from a depreciation of the currency, this effect does not appear to be the main driver of share price return for local investors.
A correlation analysis of share price movements and the USDZAR reveals that while the SA financial and retail indices exhibit a statistically significant positive relationship with the rand, interestingly, the return profile of all above mentioned rand hedges is not explained by rand movements. The implication is that, while the currency has been a tailwind over the period under consideration, it has been a smaller driver and component of share return.
Finally, as resources make up the bulk of JSE’s rand hedge universe and a potential integral part to a rand hedge strategy, it is also worth noting that the correlation of the rand with SA resources tends to be complex and non-stationary. Although the JSE Mining Index return performance over the past 5 years is broadly uncorrelated to the USDZAR, over time the rand tends to exhibit positive correlation to commodity prices and thus not always ideal for rand protection strategies.
Why own rand hedges?
In our opinion, whilst it is hard to construct a currency protection strategy from the current available pool of stocks, we believe that there is a strong case to be made for many of these investments on a stand-alone basis. Based on our work, we note that the uncorrelated nature of many rand hedges to locally sensitive stocks is an attractive characteristic from a diversification perspective. And finally, although our work suggests that many resources are offering a better medium term entry point, particularly after a difficult year for many commodities, we think the opportunity remains more attractive for higher quality non-resource rand hedges such Reinet, BAT, ABinBev and Bidcorp.