Despite money market funds investing in short-term assets, it is important to consider long-term structural issues when managing a money market portfolio. Structural issues are important as they can lead to large, unsuspected market moves. Attempting to time the market is inherently fraught, so it is preferable to position your investments to account for long-term issues. The structural issues in South Africa are the current account deficit, the fiscal deficit, pedestrian GDP growth and labour market inflexibility.

Our current account deficit, which is currently at 6.2% of GDP, needs to be funded by financial flows for the rand to remain stable. The current account should adjust as market forces, such as the strength of the currency and the level of domestic demand, change. Over the past three years the rand has weakened by 16% a year and GDP growth is now close to 0%. These two factors should ordinarily stimulate exports and reduce imports, shrinking the current account deficit. Unfortunately this has not happened.

The recent statement from the Monetary Policy Committee (MPC) commented: 'The current account is anticipated to narrow gradually over time.' No reason was given for this anticipated improvement, but it is difficult to see how it could occur without a significantly weaker rand and/ or much higher interest rates. The risk of this adjustment occurring sooner rather than later is increasing with the potential tightening of monetary policy in the US.

The money market yield curve is very steep with 12-month NCDs selling for 7.30%, compared to the Repo rate of 5.75%, but the MPC is loath to increase interest rates given the weak domestic demand. This should make the 12-month fixed rate notes a good investment over the next year, as investors can lock in the higher rates from today. However, it is important to consider the structural imbalances and the potential for a shock. For this reason we like to keep the Money Market Fund flexible and still have preference for floating rate notes over the 12-month fixed rate note.

Commentary contributed by Andrew Lapping

Over the past three months we have kept the duration of the Fund consistently long to take advantage of the steep yield curve. We achieved this though investing in six-month fixed rate notes and 12-month floating rate notes. We thought it unlikely that the Monetary Policy Committee (MPC) would increase the Repo rate while the rand was stable and the economy so weak. The inclination of the yield curve also meant that even if a rate increase occurred, it still made sense to invest in longer-dated assets rather than the lower yielding three-month area.

Our assessment of the situation has changed slightly as we think the recent rand volatility could lead to a little more caution from the MPC. Add to this the steadily rising inflation rate and the potential for a rate hike at the July meeting seems high. This means it is worthwhile letting the Fund's average days to maturity decline somewhat. This positioning will give the Fund the flexibility to invest in longer-dated, potentially higher-yielding assets after the meeting. All else being equal, we will continue to reduce the Fund's duration ahead of the meeting.

The January interest rate hike came as somewhat of a surprise as we thought the Monetary Policy Committee (MPC) would place more weight on the depressed consumer and investment expenditure, rather than the weaker rand and subsequent inflationary risks. We increased the Fund's duration slightly prior to the 29 January MPC meeting as we invested in six-month assets at yields of approximately 5.8%. Despite this, the Fund's duration was only 57 days prior to the meeting, as opposed to 67 days at the beginning of January.

Subsequent to the interest rate increase, many investors became very concerned that the MPC was beginning an aggressive hiking cycle. These expectations were priced into term rates, which led to a sharp steepening of the yield curve. The six-month NCD rate increased to 6.4%. In our view, the January hike was a bit of a knee-jerk reaction to the weaker rand and Turkey's substantial rate increase a few days before, rather than the start of a sustained hiking cycle. We have taken advantage of the higher term rates and increased the duration of the Fund to close to the maximum of 90 days.

The longer maturities still offer good value and we are discounting 100 basis points of interest rate increases within the next six months, which is probably on the high side. That said, as time passes and the effects of the weaker rand creep into prices and consequently the in#ation rate, the MPC will probably feel the need to increase rates further. We will likely reduce the Fund's duration as the next MPC meeting approaches to increase the Fund's #exibility and account for the range of potential outcomes.

Term interest rates continued to tick up over the final quarter of 2013, but only by 15 basis points in the six-month area, while the 12-month area of the curve was basically unchanged. The steadily weaker rand caused investors to be more cautious in their inflation outlook, and consequently in their outlook for interest rates.

The Monetary Policy Committee (MPC) of the Reserve Bank is in a difficult position as the South African economy is weak, but there are definite risks to price stability from the currency weakness. At the moment the base case forecast of the Reserve Bank is for inflation to remain below 6% in 2014, but the tone of the MPC statements makes it clear that the members of the Committee are cautious.

There is very little inflation globally, which is helping to keep South African inflation within the 3-6% target range, as the pass through from external sources is minimal. Commodity prices, such as the oil price, are already high and the risks are probably towards lower rather than higher prices, which will help the inflation situation locally.

The biggest risk to South African prices, and therefore interest rates, is the 6.5% current account deficit which has not moderated despite the substantially weaker rand. We have not changed our view that the next move in interest rates will be an increase. The higher six-month NCD rate makes this asset more attractive, so we have been investing in this area of the curve, as well as continuing to invest in floating rate notes.