Morningstar Pulls Back From South African Equities, Backs Brazil and Mexico Instead

Morningstar, the $375 billion asset manager, has decided South African equities aren’t worth the trade. Cheap valuations aren’t enough. Sluggish growth outweighs the discount, according to Sean Neethling, the firm’s South African investment head, who instead holds an overweight position across emerging markets broadly, with Brazil and Mexico standing as preferred destinations outside Asia.

The numbers explain the call. The FTSE/JSE All Share Index has fallen more than 4% in dollar terms this year, on track for its first annual decline since 2022. Compare that with the MSCI emerging-markets equity gauge, up 21%, driven largely by Asian firms tied to artificial intelligence. That gap, roughly 25 percentage points, is the trade Morningstar is making.

Neethling oversees about R60 billion ($3.7 billion) across rand- and dollar-based portfolios. His read: Johannesburg has missed the fund flows because it lacks growth and has no foothold in the AI theme driving global markets. “If you look at South Africa at a company-specific level, there’s not many companies that are at the forefront of what’s driving markets right now in artificial intelligence and tech,” he said in an interview. “South Africa doesn’t have that growth factor that a lot of other emerging markets have right now.”

The macro backdrop reinforces the equity case against South Africa. Africa’s biggest economy has grown by less than 1% annually for more than a decade. Add to that the fallout from the US-Iran war, which is weighing on manufacturing, trade and mining output. The South African Reserve Bank raised borrowing costs for the second time this year earlier this month, tightening the screws further on an already constrained economy.

Even the sectors that carried the market are losing steam. Gains over the past year came from gold and platinum producers. Both have since lost ground as metal prices pulled back.

By contrast, Brazil offers what Neethling calls a different proposition: large firms such as Petrobras and Vale S.A., tied to different parts of the commodity cycle, plus well-capitalised banks. Mexico brings an “industrial-staples mix,” anchored by companies such as bottler Coca-Cola Femsa. These are the names Morningstar is rotating capital toward instead of Johannesburg-listed equities.

China remains Morningstar’s strongest conviction play in emerging markets, with South Korea another top bet. The Korean market has dropped 24% from its June 22 high, a drawdown Neethling now calls “attractively priced.”

What changed the calculus for South Africa isn’t uniform, though. Morningstar’s caution stops at equities. The firm is overweight on South African bonds, where yields beat both emerging-market peers and developed-market debt. “For rand-based investors, South Africa offers really attractive and compelling value, particularly in the bond market, where absolute yields and yields to maturity are among the most attractive in emerging markets, only second to Brazil,” Neethling said.

That split says something about where the risk and return currently sit. Foreign equity capital is staying away from Johannesburg’s stock exchange, judging the growth story too weak relative to peers. Rand-based fixed-income investors, meanwhile, are finding some of the most compelling yields anywhere in emerging markets. Whether that valuation gap in equities eventually pulls capital back in, or whether the growth deficit keeps foreign money on the sidelines through next year’s reporting cycle, is the question now facing portfolio allocators watching the rand and the JSE alongside each other.