At time of writing South African investors awaited their collective fate from Fitch Ratings. While sceptics argue that rating agencies fulfil a rear-view mirror role, it often appears underrated that ethical money managers abide by a set of principles. Some of these principles include Treating Customers Fairly (TCF), Environmental, Social and Governance (ESG) and socially responsible investing, various Board Notices and Regualtion 28 of the Pension Funds Act. Some time back one of our peers received broad criticism for their outspoken comments on state-owned enterprises (SOEs), and Eskom in particular. Criticism was even issued from official sources. Fast forward a few months and one should take a step back and wonder what would happen if local investors were to take to the podium and comment about the principle of investing in government debt at this moment in time.

Against this ethical comment, we have seen record-pace foreign inflows into particularly the local bond market, speaking to the wall of money still available in a world awash with liquidity and still very low global interest rates. While South Africa appears to be getting close to index exclusion (requires only one additional action from each S&P and Moody's to be excluded from Global Aggregate, and doubleaction from Moody's and one from S&P for WGBI), foreigners continue to pile into local bonds. Strategists are collectively scratching their heads in this regard, asking whether this trend will have to reverse rapidly if, for instance, Fitch downgraded South Africa into junk territory also. If it cuts the long-term foreign currency and local currency rating and leave South Africa on negative outlook, it would be the first agency to rate SA local debt as junk, and it would start triggering some of the smaller, lesser-known global indices. While Moody's has been lenient towards South Africa, much more so than both S&P and Fitch, one should assume that on a probability of risks they will unlikely leave ratings unchanged in the 30-90 day window they have allowed for review, unless the government manages a dramatic about-turn. (Not to mention the magnitude of impact it would have if Moody's was to announce a double-notch downgrade.)

And it is on this front that we find ourselves ahead of the 18 April motion of no confidence tabled for debate in parliament. In the off chance this comment isn..t published before this date, to our mind this will be an important date for South Africa, looking back in history. Events over the past two weeks have left the country in a state of shock and investors with a deep sense of fiduciary responsibility, on par with the physician..s oath of ..first do no harm......Having witnessed macro fundamentals improving steadily over the past two quarters, we saw ourselves turning more constructive towards the sovereign and this bore out in our asset allocation shift. Recent events, however, have seen a rapid about-turn in this regard, and we fear that unless the governing party brings about wholesale changes local investors might start voting with their feet.

We have a responsibility towards investors and their hard-earned capital. Foreigners are left with many (bad) choices often ....in a world of bad apples (think Turkey, Russia, Brazil). Adding another (bad) apple such as South Africa hardly makes a difference if they are ..compensated....for their investment. In this process, the ethics of holding government to account towards its citizenry does not appear to play any factor. We continue to engage the levers of government and financial institutions to bring about positive change, for the benefit of the entire population, and not a select kleptocratic few. Until such time our portfolios will reflect the reality that market conditions are fragile, and return of capital is paramount. large positive surprise to expectations at 13.9 million tons (vs 11m forecasted). The positive impact of rains in the northern parts of the country (critical to be followed in the southern parts this coming winter for this momentum to be sustained), will see food inflation more than likely surprising meaningfully to the downside of current expectations (not only the market..s, but importantly the Reserve Bank..s). Downside surprises in inflation, and high yields on offer in the bond market (thanks to ongoing fiscal pressure after another tough National Budget), versus an ultra-conservative and orthodox SARBReserve Bank, means high real yields will remain on offer. Our fund currently offers (conservatively calculated relative to the peer group) a weighted average yield in excess of 9.00% on the pure fixed income component. However, we continue to run an unusually high conservative strategy for the current phase of the investment cycle. Typically we would identify the current part of the investment cycle as long nominal, short real, high on credit and property. Given that eEmerging markets have reached a major inflection point at the beginning of 2016, when they started to recover from extremely oversold levels. This recovery has been notably supported by restored competitiveness, improving external accounts and abating inflationary pressures. We believe that these positive fundamental trends are still in place but caution remains warranted in the short- term, (especially bearing in mind that the political backdrop locally will more than likely remain uncertain for the large part of 2017, and is expected to come with heightened volatility around key dates, such as - rating reviews, and policy conferences etc). It is because of this that we find the tabling of the recent National Budget somewhat concerning.

While the Minister of Finance was clearly determined to rectify the damage to fiscal policy credibility and, by implication, to avoid a sovereign credit downgrade to noninvestment grade status, the jury is still out on actual delivery. Based on the pushback fiscal authorities are getting post-Budget it seems South Africa is rapidly approaching the Laffer Curve from its private income tax base. We also maintain that the risk of a credit rating downgrade over the year still persists. It is unclear from this Budget, that relies heavily on taxing both corporates and individuals, while not showing much effort in more efficient spending, where the growth that is so critical to rebalance the economy is going to come from. We know that the key constraint to the South African outlook continues to relate to the political climate. It is hard to ignore the persistent rumours about an imminent cabinet reshuffle. Political risks continue to exert pressure on the listed property sector (negative impact on sentiment with the likes of Redefine and the Resilient stable making it clear that they see zero development opportunities in South Africa as a result), while the Budget also brought back familiar fears for preference shareholders in the form of increasing dividend taxes. These risks will weigh on the prospects for the rand, confidence, investment, employment and economic growth. While the future political and economic prospects for South Africa remain as uncertain as they are, we believe our portfolio positioning remains appropriate. A disciplined investment approach with a focus on macro fundamentals remains crucial. The emphasis therefore remains on capital preservation. This is expressed via a well-diversified portfolio at present, with even higher-than-usual liquidity. We have reduced our inflation-linked bond exposure to a zero holding in response to the more benign inflation outlook and instead opted to retain an overweight position in short- and medium-dated corporate bonds. The biggest risk to our cautious stance is US dollar weakness and consequent rand strength.

Conclusion
The continued uncertainty about the global, and particularly the Chinese growth outlook remains a risk - especially for emerging market commodity producers with a weak external position in both absolute and relative terms, like South Africa. The anti-global trade tirade by the Trump administration is expected to add uncertainty to the mix. Locally, the downward trend to inflation is imminent. For the while being the SA Reserve Bank will, however, continue its conservative, orthodox approach as it remains nervous about another rand event (a function of Trump and Zuma). Incoming macro data will determine the sustainability of the current cyclical upswing, whichthat has had a large positive impact on risk assets of late. The burden of proof now lies in data to support this momentum. We are nervous about the fact that volatility remains very low across global equity and currency markets. There appears an underappreciation of risk and an expectation that markets will continue to trend higher from their current elevated levels. High interest rates and stronger equity markets are not mutually exclusive if economic growth is strong. But, at present, global economic growth is merely a promise; it has not materialised in the earnings of the average company. We will look to use volatility to pick up exposure at more attractive levels.