Fund managers face higher risks.

Author:Siddiqi, Moin

The South African Reserve Bank has loosened its grip yet a little more and is now allowing insurance companies to invest a modest amount overseas. MOIN SIDDIQI examines the implications.

The partial liberalisation of exchange controls in South Africa has allowed a modest outward portfolio investment. Unit trusts have been permitted to hold 10% of assets in overseas markets since June 1996 and pension funds were given the go-ahead from October 1996. Insurance funds, which hold estimated assets of R350bn, have also now been authorised to invest 10% of their portfolios abroad as from January 1997.

In view of diminishing returns on the Johannesburg Stock Exchange (JSE), fund managers are keen to diversify their portfolios abroad. However, the Reserve Bank has reiterated that full capital de-controls are only feasible if import-cover is increased from just over one month to three.

International fund managers may find 1997 a year of relatively high risks and low returns: Global equity and bond market valuations are looking rather expensive, hence downside corrections remain likely. Near-term risks in most leading economies, especially the US and the UK, are higher interest rates. Some analysts and investors fear a repeat of 1994, when robust US growth compelled the Federal Reserve to raise interest rates. A change in US monetary policy is thus vital for global investors.

The US inflation and interest rates cycles have probably reached a low and there is high chance that US monetary policy will tighten, either in this quarter or the next. If so, US long bond yields will rise and equity prices will undergo a significant correction like they did in early 1994. If Wall Street tumbles, overseas markets, including the JSE, the tenth largest stock market in the world, will fall.

The US stock market is approaching its peak: The Standard & Poor 500 index has risen steeply by 65% over the past two years. However, dividend yield is at its lowest level on record, below 25, indicating over-valued shares. Experience shows that when a market enjoys a strong bull-run for two successive years, a bear market is likely during the third-year. However, some analysts believe that any 1997 US market sell-offs could be modest. A 5% to 10% correction in its equity prices is envisaged, prompting a retreat in global stock markets at some point during the year.

Factors which boosted financial asset prices in 1996 are unlikely to alter radically. US inflation is projected at...

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