Whether they like it or not, emerging markets investors might be pushed into the South African stock market this year.
In 1995, the country will become part of major emerging market composite indexes, and inclusion in the indexes means emerging market indexers will have to lift their South Africa weightings sharply to meet index weightings.
In addition, many active managers probably will at least consider the South African market, if they don't already, because of its sudden and large presence in indexes.
This year, South Africa will be woven into the composite emerging markets indexes of the International Finance Corp., Baring Securities and Morgan Stanley Capital International.
Starting April 1, South Africa will comprise 13% of the IFC's global emerging markets index and 20% to 21% of its investible index. (For the remainder of 1995, the IFC also will offer its composite indexes without South Africa in them.) Starting March 31, South Africa will become part of the Baring Emerging Markets Index, with an 8% to 9% weighting; and on March 1, South Africa will become part of MSCI's composite emerging markets index. Preliminary work suggests that South Africa will constitute about 11% to 12% of MSCI's Emerging Markets Free index.
(South Africa has long been part of the FT-Actuaries World index series. As of the end of November, that market had a 1.4% weighting in the FT-A World Index of 26 countries.)
The expected result of South Africa's sudden and large presence in emerging market indexes is a rush of new investments. Ian Wilson, editor of the Micropal Emerging Market Fund Monitor, Glen Allen, Va., estimates "at minimum, probably a couple of billion dollars will be invested in South Africa in the first six months of 1995."
The big inflow will be coming because many managers still haven't invested much in South Africa - certainly nowhere near indexed weightings. According to Micropal Emerging Market Fund Monitor, at the end of the third quarter, 165 emerging markets funds with $38.5 billion in total assets had only 0.9% invested collectively in South Africa.
Emerging market managers who haven't yet invested much in South Africa might have a problem. Even if they want to invest in that market - and some are unenthused about it right now - they're confronted with a market of limited liquidity. Officials at Baring Securities, London, say that because of significant cross-holdings and other problems, available shares are limited for even the largest South African shares. Baring estimates only 23% of the market capitalization of the stock of Anglo American Corp. is available to be purchased; free float is an even lower 20% of the market cap of De Beers Consolidated Mines Ltd.'s stock.
Such limits should prove inflationary in a sought-after market. "Managers are frustrated," said Elizabeth Morrissey, vice president of Kleiman International Consultants Inc., Washington. "Some are trying to come up to a 13% weighting, but you just can't buy" that much because the market "is so illiquid. People will continue to try" to move up their South African weightings. And as they do so, they'll "artificially inflate the prices of those few stocks that have (noticeable) turnover in trading," she predicted.
Of course, managers who already have placed their bets on South Africa are pleased; they expect the market, which performed well last year, to continue advancing in 1995 as more money pours in.
London's Foreign & Colonial Emerging Markets Ltd. has a 7%
South Africa exposure. The firm is happy that South Africa will join composite emerging markets indexes in 1995.
"We expect the amount invested in that market to increase early in the first quarter of 1995 and reflect higher share values," said Jean de Bolle, the firm's head of strategy.
G.T. Capital Management, San Francisco, has between 8% and 10% in South Africa in its 17 global emerging markets portfolios. "G.T. has a positive long-term outlook on that market and expects South Africa to achieve annual economic growth of 4% to 5% over the next three years," said Nick Mencher, the firm's institutional marketing director. The firm began buying South African shares in February 1994.
South Africa's appearance in emerging market indexes isn't good news to some managers. Montgomery Asset Management, San Francisco, has a 0.5% weighting in South Africa in its global emerging markets portfolios. The reason: "we don't feel South Africa offers compelling value today," said portfolio manager Tom Haslett, who points to the market's price-earnings ratio of 18 to 19 times 1995 earnings. He also cited such other deterrents as South Africa's dual currency system (which is expected to be eliminated in 1995); lingering questions over the country's economic policies and expected growth levels; and problems linked to cross-holdings among South African companies and local trusts. In Mr. Haslett's view, "there are better (strategies) than having 13% to 20% invested in South Africa."
State Street Global Advisors, Boston, manages three indexed emerging markets portfolios (including one separate account for an unnamed pension fund) and five actively managed emerging markets accounts. For the indexed funds, State Street will begin investing in South Africa in the first quarter and slowly build up to the indexed weighting; for the active accounts, State Street already began investing in that market starting in October, said Vice President Joshua Feuerman.
In its actively managed emerging markets accounts, State Street now has between 3% and 5% in South Africa. "As we get more contributions into the funds, we can move closer to the benchmark weighting for South Africa," said Mr. Feuerman. "But our ultimate weightings will depend on the valuation of that market; right now, South Africa is not particularly attractive. So we'll probably stay at a slight underweighting."
Clearly, some pension funds are eyeing South Africa - both for listed shares and private placements. For some of these investors, the attraction to that market is both political and financial. As Philip Schaefer, president of San Francisco's Pensions 2000 group, put it, "I think pension sponsors are listening" to the call by South African President Nelson Mandela to invest in that country.
During a recent trip to South Africa sponsored by Pensions 2000, Jim Hill, treasurer of Oregon, investigated several direct investment vehicles. He was accompanied by Dan Smith, director of investments of the Oregon Public Employes' Retirement System. "The most important thing is to get (an attractive) return for PERS. I would like to find ways to accomplish that and contribute to empowering blacks in South Africa," said Mr. Hill. On the trip "we were able to find some (unnamed) investment vehicles that would accomplish both missions."
Henry Sciortino, deputy treasurer of Pennsylvania, also joined Pensions 2000's trip to South Africa. He now expects to make a recommendation to state Treasurer Catherine Baker Knoll that "South Africa be near or at the top of what we do in emerging markets." That recommendation should be timely, considering asset allocation reviews are now under way at the state's two largest funds, the Pennsylvania Public School Employes' Retirement System and the Pennsylvania State Employes' Retirement System.