A global phenomenon
While this is quite a big problem, it’s actually a global phenomenon and not just specific to South Africa. From 2015 to 2022, we've seen very similar trends: Germany's Deutsche Börse has 36% fewer companies, the London Stock Exchange has 22% fewer companies, even the Swiss Stock Exchange has 22% fewer listings.
A key factor behind this trend is the incredible growth in the private markets globally over the last two decades fuelled by record-low interest rates. We've seen many companies staying private for longer and listed companies being taken private through leveraged buyouts using cheap debt.
South African specific challenges
However, South Africa does have some specific local challenges driving the shrinking JSE. There has been a dearth of new listings on the JSE for a very long time. That's largely due to low company formation amidst weak economic growth and the obstacle of onerous JSE-listing requirements. There has also been a significant wave of delistings.
A valuation argument could be made as we have seen foreign investors taking advantage of the depressed valuations and the weak exchange rate to do bolt-on acquisitions and subsequently delist the acquired company. Heineken’s purchase of Distell is a good example.
However, we've also seen companies delisting because they want access to deeper pools of capital which aren't available in South Africa. Alternatively, they are looking to avoid the structurally lower valuations of the JSE that come from the country risk premium and unlock value for investors by listing elsewhere. A prime example is AngloGold Ashanti seeking to move its primary listing to the New York Stock Exchange.
Why this trend creates challenges for investors
This trend highlights the broader problem of a shrinking set of local investment opportunities. We still have large financial institutions in South Africa – think pension funds, investment managers and insurers – which are forced to invest in this shrinking local universe due to regulatory foreign investment constraints that lock capital into the country.
Where you have all this capital to invest locally but not enough options to invest in, you get a structural supply-demand mismatch, which we've seen show up in the oversubscription of new issuance in the debt market, for example.
As economics dictates, if you have too much money chasing too few goods or too few investments, the price goes up. As an investor, paying a higher price means you're going to be earning less return for the risk you are taking.
South African credit is a good example of this hothouse effect. Credit spreads, which show the additional return an investor will earn above risk-free government bonds for taking on credit risk, are sitting at 110 points. Globally, high-yield credit gives you about 460 points of yield above the risk-free rate, so you're getting quadruple the return per unit of credit risk. South African investors are just not being compensated accordingly for risk in the shrinking local opportunity set.
What should investors do
A further reason we have such low-risk premia in South Africa is the base effect of the rising cost of borrowing for the government. The sovereign risk premium in government bonds has shrunk the risk premium in riskier asset classes. So, the first, most obvious, option an investor could consider is government bonds, which are paying really high rates of return for the amount of risk you're taking. At 10X we think it's important, now more than ever, for investors to diversify globally and take advantage of higher quality, more abundant opportunities where you are being compensated for risk and don't have this supply-demand mismatch in the market.
