Brazil vs SA: Accountability boosts returns

In 2016 Brazil and South Africa faced similar challenges: falling economic growth, rising debt, growing unemployment, fears over credit ratings and widening corruption scandals. Investor confidence in both countries, as a result, took a huge knock.

But data from Old Mutual Investment Group (Omigsa) shows that investors that bet on São Paulo’s benchmark Bovespa exchange from January 1 2016 to date are faring better than those punting Johannesburg’s All Share over the same period.

Source: Omigsa Q3 Briefing

At face value, the difference in returns seems questionable as Brazil’s woes appeared far greater than our own.

By the end of 2016, Brazil’s economy had contracted for eight consecutive quarters or two years straight shrinking by almost 8% while South Africa’s economy grew by 1.5% over the same two-year period. The Brazilian government’s balance sheet was more strained than our own although its fast-growing unemployment rate wasn’t as high. It had already faced a spate of sovereign credit ratings downgrades to junk whereas South Africa’s first sub-investment grade downgrade came in April 2017 just weeks after Pravin Gordhan was fired as finance minister. And a far-reaching criminal investigation, Operação Lava Jato or Operation Carwash, revealed a country steeped in corruption.

Source: Omigsa Q3 Briefing

Operation Car Wash, which began as an investigation into money laundering, revealed billions of dollars in misappropriated funds at Petrobras, the state-run energy company. More than 230 people were investigated, with 160 arrested, 179 indicted and 93 convicted. Sitting president Dilma Rousseff was impeached with current president Michel Temer, who vowed to clean up the government, said to be facing a similar fate. The country’s hugely popular former president Luiz Inácio Lula da Silva, was sentenced to almost 10 years in prison after being found guilty of corruption and money laundering (Lula is fighting the conviction and is currently the lead candidate in the country’s 2018 presidential election race).

Why, in light of this, did investors in Brazil reap greater rewards than those in South Africa?

According to Siboniso Nxumalo, joint head of Omigsa’s global emerging markets boutique, the market rewarded the actions of Brazil’s government and its citizens’ widespread protests whose attempts to address corruption provided some comfort.

“Confidence matters. If you look forward people say that something is happening in Brazil, they’re fixing their issues, they’re dealing with their issues [and] so we’re going to invest there. Their confidence increases as they’re seeing tangible steps being taken by government there, that’s what we need to do,” he said.

Operation Car Wash, Brazil’s attempt to address its corruption scandal has been running since 2014 while the extent of so-called state capture in South Africa is still being uncovered. Nxumalo’s presentation in Johannesburg sought to show that it still possible to profit from chaos in emerging markets and that decisive action to address problems can go some way to restoring investor confidence.

Thus far, no one has been charged for crimes related to state capture and public protests have yet to spur action. According to Nxumalo, who along with his team experienced protests in Brazil first-hand, the scale of protests by Brazilians feeling the effects of a recession and skyrocketing inflation forced lawmakers into action.

“There were two million people in São Paulo, in Brasilia – the capital of Brazil – there were 1 million people, in Rio – a holiday town – there were 1.4 million people. The politicians looked at this and said ‘this number is too big to ignore’. They did what politicians do, they changed sides and said ‘let’s arrest those people’.”

“In South Africa, at the moment, we are bumbling along so no one is really too affected by it. Until it hits our pockets and people actually feel the effect of what we are going through, there will be [no] response…We are still relaxed about things and we are hoping for a self-correction whereas in Brazil, they realised that there was no self-correction coming so they dealt with it.”

He said that political and policy certainty as well as accountability for bad behaviour may go some way to restoring investor confidence.

A lack of clarity and probable binary outcome of the ANC’s upcoming conference, where it will elect a new party leader, is now said to be weighing on investors.

“Investors are going to sit on the side-lines especially because they can get better returns at lower risk and more clarity elsewhere. As a country, we need to understand that we are in a global world and we are getting left behind because we aren’t providing what other countries are.

Capital has got competition. Ultimately what investors want is a return – that is all they are after – they don’t have time for patience for us to sort out our stuff. If they see opportunity elsewhere, they’re going to go for it.”

Still, Nxumalo said Omigsa is currently sees South African banks and hospitals as more attractive relative to their emerging market peers. He added that Omigsa’s Emerging Markets Fund is seeing more opportunities in South Africa now that asset prices have fallen as it equates lower asset prices with lower risk.

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