JSE in trouble – and so are South African investors

The Johannesburg Stock Exchange is shrinking, significantly shallowing South Africa’s capital markets, which harms economic growth and limits the investment universe for local investors. 

In its first Financial Stability Review of the year, the Reserve Bank warned about liquidity in Africa’s most developed financial market drying up. 

It said that local capital markets have become shallower and less liquid over the past years, reducing the ability for borrowers and investors to diversify. 

In particular, the government has come to dominate the local bond market, increasing its share of total outstanding bonds from 60% in 2008 to 81% in February. 

The Reserve Bank warned that this has made local financial markets less resilient to external shocks and created a single common risk for all financial institutions. 

Meanwhile, the JSE has experienced a spate of delistings in the past decade. The last year the number of companies on the exchange increased was 2015. 

The exchange’s operator, JSE Ltd., explained that this is a global phenomenon. However, South Africa has been uniquely hard hit. 

Lacklustre economic growth has reduced the available pool of savings to invest in local companies, and onerous listing regulations have made it increasingly unattractive for companies to list. 

The Reserve Bank noted that domestic bond and equity market turnover has declined in recent years. This affected efficient pricing, investor returns, and the cost of funding.

The reduction in turnover has also negatively impacted JSE Ltd.’s trading revenue in its most recent financial results. 

This is a more pernicious issue than the trend of delistings, as it is effectively out of the company’s control. It is largely a factor in South Africa’s poor savings rate. 

The graph below shows the declining turnover of the bond and equity markets, which has been sustained since 2010. 

The Reserve Bank said there are several reasons why this is the case with Africa’s premier stock exchange. It highlighted ta stagnant economy resulting in low growth and poor domestic savings rates. 

However, the bank also said that the government has crowded out private sector debt on the exchange because it requires increasing debt to fund its operations. 

Foreign investors have also decreased their investments in South Africa in recent years, reducing liquidity on the exchange.

Over the past decade, local equities have underperformed the S&P 500 in US dollar terms by around 10% per annum. 

Not only has the JSE underperformed the world’s premier stock market, but it also has underperformed its emerging market peers. 

Ninety One portfolio manager John Biccard said this is because of bad news being priced into local stocks, making them attractively valued. 

South African shares are trading at record-low valuations relative to other emerging markets and their more developed peers. 

Worryingly, local shares are also near all-time lows in absolute terms. 

Impact on investors

The decreasing number of companies listed on the JSE has led to increased market concentration risk for local investors. 

PSG Wealth’s Wendy Myers said the local delisting trend has proven to be particularly acute due to the relatively small size of the exchange. 

While many rand hedge companies with large international operations have been protected from South Africa’s poor economic growth, companies with local operations have not been spared.

Myers said market concentration risk is the key implication of a shrinking investment universe on the JSE. 

The JSE is effectively dominated by a few market heavy-weights, including, for example, China-related internet counters like Naspers and Prosus and commodity stocks. 

Investors have tried to circumvent this by increasingly investing in exchange-traded funds (ETFs), assuming this will give them adequate diversification. 

Myers cautioned against this, saying that these instruments track an index, and with such a small investment universe in South Africa, they will only expose you to a few companies. 

“In general, when considering equity investments, it is very important to ensure your portfolio is well-diversified, and similarly, the JSE should not be your only form of equity exposure,” she said.

“International diversification is key, and investors need to consider exposure to other currencies and geographies in their portfolios.” 

PSG Wealth recommends allocating almost 40% of a total portfolio to international securities.