JOHANNESBURG South African pension funds have cut their holdings in local government bonds to the lowest level in nearly 4-1/2 years because of political turbulence in the country, but yield-hungry foreign investors are proving less hesitant.
Domestic pension funds have historically been the largest investors in South African government bonds, but National Treasury numbers show their share has fallen to 27.2 percent as of end April -- the lowest since December 2012.
Conversely, foreign investors have been buying, according to data from the Johannesburg Stock Exchange, and now hold 39.4 percent of the bonds -- their highest level on record. The rest are held by banks and other financial companies.
Local funds have steadily decreased their holdings in government debt since January 2016, after President Jacob Zuma changed finance ministers twice in one week at the end of 2015.
The moves led to a sharp sell-off in the rand currency and bonds.
But the political risks were heightened even more in March this year when Zuma dismissed respected finance minister Pravin Gordhan, leading to credit ratings downgrades to "junk" status by S&P Global Ratings and Fitch.
Moody's, whose Baa2 rating is two notches above "junk", put South Africa on review for a downgrade.
"Locals are definitely more worried about the bonds and the rand because of the (latest) cabinet reshuffle. They're more cautious about having big bond holdings," Ashburton Investments portfolio manager Wayne Mccurrie said.
Investors fear policy steps to spur on the economy and keep debt in check are taking a backseat to corruption scandals and the jostling for positions as Zuma's ruling African National Congress (ANC) prepares to elect new leaders in December.
Indeed, leaked documents released by South African media on Thursday alleging improper dealings in government contracts were seen healing more pressure on Zuma.
"We are underweight nominal bonds and duration on South African bonds," said Wikus Furstenburg, portfolio manager at Futuregrowth, which has about 170 billion rand ($13 billion) of assets under management and ranks as one of Africa's largest money managers.
The yield on the benchmark government bond due in 2026 ZAR186= rose to a 4-month high of 9.2 percent in the aftermath of Gordhan's axing, and at the current 8.55 percent appears attractive to foreign investors.
But locals want a bit more to account for the risk.
"It's simple, the yield needs to adjust to make it more attractive for the more pessimistic managers like us to get back into the market," Furstenburg said, adding that low economic growth and widening capital deficit were other major negatives.
With local money drying up and foreign loans becoming more expensive after the recent downgrades, South Africa has moved closer to the brink of a funding problem.
Analysts also say inflow into government bonds from foreigners, at 44.6 billion rand ($3.42 billion) year-to-date and nearly double the corresponding period in 2016, could be short-lived if political tensions don't ease.
"This is certainly a problem but not quite yet a crisis," said Investec co-head of fixed income Nazmeera Moola of Treasury's funding fix.
"There is a possibility that Treasury doesn't take any hard steps and continues to borrow more, that's what leads to a debt crisis and higher debt to GDP ratios," Moola said.
South African debt has already been dropped from one the widely used global bond indexes, the JPMorgan Emerging Market Bond Index Global, and risks being excluded from the larger Citi's World Government Bond Index, if both Moody's and S&P's cut the rand-debt rating to "junk".
Estimates put the cost to the country of falling from these indices at around $20 billion in investment funds.
An additional danger is that South Africa depends on foreign money to cover its large budget and current account deficits. This huge reliance leaves it highly susceptible to global investor sentiment volatility.
Isabelle Mateos, BlackRock's chief multi-asset strategist, said South African bonds offers opportunities and continue to draw the bulk of flows to emerging markets.
But she said this would quickly change if politics did not improve.
"South Africa is not one of our favourites, and that has to do with political and policy uncertainty. We are not actively shorting South Africa but the upside is very limited," she said.
(Graphic by Jeremy Gaunt. Editing by Olivia Kumwenda-Mtambo/Jeremy Gaunt)