AND THE RAND PLAYS ON — WEAKLY

Gold-rich South Africa has lost its luster for U.S. fund managers following nearly three months of volatility in its currency — the rand — and its negative implications for economic growth.

The rand has plunged 35% over the past 11 weeks, hitting an all-time low of 6.75 to the dollar last month. While it has since regained some ground — it was trading at 6.24 to the dollar last week — investors still fear further weakness lies ahead.

But despite the ability to get that much more rand for their dollar, U.S. investors are fleeing the market for a host of reasons.

Their returns have been slashed in both dollar and rand terms; they dislike countries with volatile currencies; and they are waiting for the rand to fall even further.

good money after bad

The South African Reserve Bank wasted much of its precious gold and foreign exchange reserves in a vain attempt to protect the rand. When that failed, it hiked interest rates.

That has dampened the prospects for sound economic growth this year and next, has raised the specter of rising inflation and is expected to impact negatively on corporate profits, say market watchers. Not an attractive scenario for foreign investors.

Kevin Jacobs, a trader and strategist at stockbroker Barnard Jacobs Mellet (U.S.) in New York, says those emerging market fund managers who have to be invested in the country are still there — albeit at a weighting below that of their benchmark index.

“The emerging market fund managers we deal with are looking at Brazil first, followed by Mexico and then S.A. And general investors are definitely looking elsewhere, particularly at the many attractive opportunities that currently abound in Europe and Latin America,” he says.

This is borne out by a recent Merrill Lynch survey, in which leading fund managers in the U.S., Continental Europe and Britain placed South Africa dead last when asked to name the most attractive region for next year. Latin America was first, followed by Continental Europe and Asia.

John Morris, Merrill’s strategist for South Africa, says Latin America is topping the popularity stakes as it appears more isolated from the current crisis in emerging markets.

Global investors are also attracted to Continental and emerging Europe, where active restructuring will result in reasonable earnings growth — something that’s becoming difficult to find as the world’s major economies show signs of slowing down.

“South Africa’s growth prospects have been dashed on the back of high real interest rates, which is deterring foreign investors. We expect GDP growth of just 0.8% this year and 1.2% next year. And with interest rates at around 20% and inflation expected to rise to 7% by the yearend from the current 5%, the economy is set to slow down — and that’s unattractive to global investors,” Mr. Morris says.

The latest figures from the Johannesburg Stock Exchange and the Bond Exchange show that total net foreign investment in the bond market year to date plunged to 3 billion rands as of the end of July from a high of 16 billion rands in April. And interest in equities is also on the wane.

But not everyone is so pessimistic. U.S.-based Magnum Global Investments recently sponsored a new hedge fund — the Scott Performance Fund — to give institutions and high-net-worth individuals the chance to invest in South Africa through flexible hedging strategies.

Keith Scott, co-manager of the new fund, says the South African economy is gearing for growth that is not yet reflected in many securities prices.

But Kevin Cousins, who manages the Omni Fund for the Board of Executors, a South African banking and investment group, says it’s too early for an international investor to come into the market as another run on the currency is likely.

quick turnaround

While fund managers were extremely bullish a few months back — driving the equity market up over 40% from its January low in the expectation of sharply lower interest rates — the recent currency crisis quickly changed their view.

“The prime lending rate has risen to 24% from 18.25% — and the equity market has been knocked back down about 20% in rand terms, while the dollar number is even grimmer,” Mr. Cousins says.

But the Omni Fund’s investment strategy is to buy companies that have the agility to deliver their earnings no matter what the broader economy does.

“We limit our rand exposure in the fund by holding cash in dollars and some short positions on S.A. stocks,” Mr. Cousins says.

Rob Lee, an economist who consults for the Board of Executors, believes South Africa will start generating current account surpluses within a few months.

If the commodity price outlook improves or confidence returns to emerging markets in 1999, then this would be the time for U.S. investors to come back, especially if privatization and other market-based reforms are then also speeded up.

Where then are the opportunities? David Murray, the head of equity sales at Deutsche Morgan Grenfell in New York, says investors should favor bonds over stocks.

“Bonds have outperformed equities by close to 30% over the last three years. And, following their weak performance over the past six months, returns over the next year could exceed the equity market,” he says. He recommends an underweight position in growth stocks and overweight in cyclical stocks on the back of the currency slump.

Merrill’s Mr. Morris also likes bonds, given the slowing economy.

“And earnings-defensive stocks, like financials,” he says, “should not be disregarded.”