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South Africa ETFs in Focus on Rating Downgrade

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The South African economy has been experiencing low demand for exports and going through political turmoil that has weighed on its economy’s growth.

Sequentially, GDP declined an annualized 0.3% in the fourth quarter of 2016 and 0.7% in the first quarter of 2017. However, it grew 2.5% in the second quarter of 2017.

Rating Downgrade

S&P downgraded the country’s credit rating to junk status. It lowered South Africa’s local currency credit rating to BB+ from BBB. Moreover, the rating agency also lowered South Africa’s international debt rating by a notch to BB. S&P cited concerns over the country’s economic scenario and fears of further deterioration in public finances due to the weakness in GDP.

Moreover, Moody’s Investors Service put South Africa’s Baa3 rating in review for downgrade, as the rating agency expects a faster-than-expected rise in the government’s debt-to-GDP ratio, weaker growth prospects and expected shortfall in budget. The rand took a hit as a result of this.

Moody’s decision to put the rating in review instead of an immediate downgrade is a positive. A decision to downgrade might trigger local currency debt to exit various global bond indices.

What Lies Ahead?

South Africa’s finance minister Malusi Gigaba reduced the country’s growth forecasts for this year to 0.7% from 1.3% earlier. The recent downgrade might lead to a further reduction in foreign direct investment and investors fleeing the country.

South Africa's unemployment rate came in at 27.7% in the third quarter of 2017, same as the previous quarter. Moreover, the country has been going through immense political turmoil. President Jacob Zuma was under scrutiny for maintaining illegal ties with the Gupta family and the firing of finance minister Pravin Gordhan.

Zuma survived the eighth no-confidence motion by opposition parties trying to unseat him. The motion fell short by just 24 votes. The opposition cited the result as a show of optimism and strength in their fight against the apparent corrupt practices of Zuma and a means to invigorate confidence in them to fight him in the courts.

The markets will be closely watching African National Congress (ANC’s) electives conference in December and the 2018 budget. Investors will be eyeing the party’s response to recent events and tackling of the economic situation being faced by the country.

Let us now discuss the most popular South Africa ETF in detail.

iShares MSCI South Africa ETF (EZA - Free Report)

This fund offers exposure to the emerging market nation of South Africa by investing in companies based out of the nation.

EZA has AUM of $464.9 million and charges a fee of 64 basis points a year. Consumer Discretionary, Financials and Materials are the top three sectors with 35.1%, 24.1% and 12.0% allocation, respectively (as of Nov 24, 2017).  Naspers Limited, Sasol Ltd and Standard Bank Group are the top three holdings of the fund, with 26.4%, 5.1% and 4.7% exposure, respectively (as of Nov 24, 2017). EZA has returned 22.7% in a year and 19.9% year to date (as of Nov 24, 2017). It has a Zacks ETF Rank #4 (Sell) with a High risk outlook.

We will now compare the performance of EZA with a broader Africa-based ETF, AFK (see all Africa-Middle East Equity ETFs here).

VanEck Vectors Africa Index ETF AFK

This fund has more than 50% allocation to Africa, covering economies such as South Africa, Egypt, Nigeria, Morocco, Kenya and Mauritius. It also invests in offshore listings of companies incorporated outside Africa but generate at least 50% of their revenues from the continent.

It has AUM of $76.0 million and charges 79 basis points in fees per year. The fund has 30.2% exposure to South Africa. Financials, Materials and Consumer Discretionary are the top three sectors with 36.3%, 18.1% and 12.6% exposure, respectively (as of Oct 31, 2017). Naspers Limited, Commercial International Bank Egypt Sae and Safaricom Ltd are the top three holdings of the fund, with 9.6%, 6.3% and 5.5% exposure, respectively (as of Nov 24, 2017). The fund has returned 25.6% in a year and 23.3% year to date (as of Nov 24, 2017). As such, AFK currently has a Zacks Rank #3 (Hold) with a Medium risk outlook.

Below is a chart comparing the year-to-date performance of the two funds.

Source: Google Finance

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