/ 7 September 2008

How safe is your money?

With banks collapsing in the United States and news last week that a local brokerage closed its doors, investors are understandably concerned about whether their money is safe.

Market risks are something we all understand. If we put money in shares, bonds or property, the price might go down. But what about the intrinsic safety of our investments? What if the institution which holds our money goes under?

Money in the bank: South African deposits probably safer than most
Stephen Rogers, joint managing director of Taquanta Asset Managers, said South African banks remain safe for deposits despite the turmoil in international financial circles. He said South Africa’s banking sector is relatively safer than its global counterparts because of the tough local banking regulatory environment, the implementation of Basel II, the size of the local market and the fact that local banks are more likely to raise offshore funding than place funds offshore. “The infancy of the local credit derivative market also helps, as have our foreign exchange controls, which have limited offshore exposure,” said Rogers, adding that the local interbank market is still robust. In other words, banks are still lending to one another.

The South African Reserve Bank is one of a handful of central banks that have not had to provide distress liquidity to its domestic financial system in recent times. “The strength of our market was underscored this week by African Bank Investments Limited’s (Abil) placement of R1,25-billion into the local investment market,” he said.

Razia Khan, economist for Standard Chartered, said the origins of the crisis stem from exposure to subprime assets and that South African banks have had relatively little exposure. “However, the crisis has affected the domestic banking sector, as banks have found it more difficult to raise the financing they need, especially through offshore syndications and bond issues. But rather than impact adversely on the domestic banking sector, this is likely to do no more than slow their expansion a touch.” Khan said that although there has been a strong growth in credit in recent years, local banks are not overextended and neither are their sources of finance at huge risk. “Although non-performing loans have been rising, they have been doing so from remarkably low levels. This means the money that South Africans have in their bank accounts is probably safer than in many other countries.”

Money market funds: do your homework
Reputable money market funds will be compliant with Regulation 28, which governs retirement savings. Regulation 28-compliant funds have strict regulations to protect clients from any potential capital loss. One such rule is that no single investment can be more than 20% of the fund’s total exposure – which forces the fund to be diversified.

You need to find out what percentage of your money market fund is made of F1+ assets. This is the highest-rated short-term investment available. You also need to ask how diversified the fund is across various institutions. The levels of liquidity are also important so that the fund can meet any withdrawals. During these difficult times it is advisable for a fund to have a high level of liquidity and have further funds on call.

For example, has the fund made use of call bonds that are government- guaranteed? Does the fund have any exposure to lower-rated F2 institutions or derivative-type structures, which increase the risk profile? It is important to ensure you are with a well-managed money market fund during periods of financial instability.

Government bonds: sovereign risk unlikely to rise, but shaky returns expected
Government bonds have value only if the government is able to repay the loans to investors.
Rating agencies are watching our global rating carefully as our political developments unfold. At the moment South African government bonds are considered investment-grade. Khan said that South Africa’s rating is not seen to be at risk and that the political transition is unlikely to be enough to alter that. It is unlikely, therefore, that South Africa would default on repayment. But there is increased investment risk. Khan said that given the liquidity of bonds, the bond market is always vulnerable to a sell-off. Many factors can influence the bond prices — from inflation rising more than expected to global risk aversion causing investors to liquidate emerging market holdings. “Bonds are vulnerable to shifts in global sentiment and the global economic outlook remains downbeat. There is a strong possibility that South Africa’s budget surplus may disappear altogether when the medium-term budget is read next month, which is a further negative for bonds.”

Listed securities: stick with JSE-backed investments
This week Dealstream, a brokerage that dealt in derivatives, had to close doors and clients are likely to lose all money held by the firm. This highlights the importance of the instruments you are investing in and how that relates to the credit risk of the company. Dealstream traded in contracts for difference (CFDs). These are not managed by the JSE and effectively are contracts between two parties, with the brokerage carrying the risk. When trading CFDs, effectively the brokerage firm’s credit risk is taken on. Shares or securities, such as single-stock futures, which are traded through the JSE, offer far more protection as there is the backing of the combined balance sheet of all the members of the JSE. Moreover, reputable JSE-registered stockbrokers would keep all clients’ assets in a trust account so that they are protected from any claims against the stockbroker. The brokerage would be a member of the JSE Guarantee Fund, which holds assets in excess of R80-million and protects against a member (a stockbroker) defaulting. A client can institute a claim against such a broker through the JSE Guarantee Fund.

Unit trusts: protected by trusts
Di Turpin, head of the Association of Collective Investments, said investors are protected if the collective investment manager, or any holding company that owns the manager, goes bankrupt, as the units are not owned by the company but are held in trust on behalf of the investors. The investments do not form part of the company’s assets and are held in safe custody by the fund’s independent trustees. “The trustees are usually one of the major banks and may not be connected to the asset manager in any way. It is important to note that any cash held by the fund is also held in trust and cannot be used by the collective investment schemes manager, asset manager or their creditors,” she said.

Turpin said in the event of a manager going insolvent the Financial Services Board would appoint another manager to administer the fund. She said that, in addition to the protection measures within the collective investment structure, there are strict rules governing how the assets may be invested. Exposure to any one security or institution is limited, depending on certain criteria concerning that instrument’s size and place in the market. “For example, funds may not hold more than a maximum of between 5% or 10% of a particular stock on the JSE Securities Exchange. The exposure of unlisted stock is also strictly limited.”