JOHANNESBURG – The on-going increase in foreign participation in South Africa’s equity market could put it at risk in a crisis event.

Research by Bank of America Merrill Lynch suggests that 46% of the free-float of the JSE All Share Index is owned by foreigners, slightly lower than the record 48% achieved in July last year. If dual-listed companies are excluded, the figure is 42%.

Around 63% of the resource sector is foreign-owned, followed by industrials (48%) and financials (26%).

The chart below highlights the increase in foreign ownership over time.

Source: BofA Merrill Lynch South Africa Strategy, STRATE (30 Jan 2015)

Speaking about themes emerging from its 16th Annual Bank of America Merrill Lynch Investor Conference, John Morris, investment strategist, said there has been an on-going increase in foreign participation in the South African equity market.

Ten years ago around 10% of the free-float of the industrial index was foreign-owned, but this has increased to almost 50% – largely driven by the surge in exposure to retailers and growth stocks like healthcare and media.

He said in the wake of the global financial crisis investors were looking for growth and yield. South Africa participated in the consumer growth story in emerging markets and with top quality companies with high returns on equity (ROEs) and good dividend yields it increasingly attracted the attention of foreign investors.

During the period following the financial crisis, the foreign ownership of South Africa’s bond market also increased quite substantially, he said.

In recent months, all eyes have been on the US Federal Reserve for indications of when it might start to hike interest rates. Its quantitative easing program came to an end in October last year. Emerging markets (like South Africa) have been a beneficiary of the heightened liquidity worldwide and fears have arisen that a hike in interest rates in the US could see foreign money flow back to developed markets.

But Morris says it would take a “crisis event” for foreigners to pull out of South Africa. History has shown that if the rand were to weaken substantially and bond yields went up aggressively the market would come under pressure.

The Fed has already indicated that it would react very mildly and the global economic situation is still quite weak. Therefore, this is unlikely to happen, Morris said.

However if the global cycle had to improve there would be less reason to bid up stocks for their growth prospects. If the world economy recovered and moved back to a normal business cycle, investors would look for cheaper, underperforming stocks elsewhere and there could be some outflows, he said.

But the world has been in an elongated cycle of weak economic performance and it will likely take a long time for it to recover and move back to a normal cycle.

“I think for that reason you could argue that you won’t see that event [a foreign exodus] take place,” he said.

“In addition, ECB [European Central Bank] and BoJ [Bank of Japan] liquidity is still plentiful, an underpin. But with assets at/near record highs and 2015 the first year since 2006 that the Fed hikes, the result is likely to be lower and more volatile returns.”

Morris said the investor conference reaffirmed that a foreign exodus is not likely at this point in time. Foreign investors have been adding to their positions and seem to be comfortable investing in the current environment – in quality, growth companies.

The conference is an opportunity for chief investment officers of local and international fund managers, pension funds and hedge funds with emerging market mandates to meet with chief executive and financial officers from corporate South Africa.

Article credit: http://www.moneyweb.co.za/investing/equities/how-foreign-equity-ownership-has-changed/