''When I have nothing to say, my lips are sealed. Say something once, why say it again?"
"Talking Heads, "Psycho Killer"

Few money market fund commentaries start with a quote from a song about a serial killer. It is nonetheless appropriate, since little has changed over the recent quarter. David Byrne from Talking Heads would suggest we copy and paste the previous quarter’s commentary. Instead, the main points are repeated below:

? South African money market investments are attractive amidst global uncertainty. Absolute returns close to 8% are sufficiently higher than 5% inflation to grow client wealth at low risk.
? On a relative basis, money market investments have outperformed higher risk South African asset classes over recent years. We do not expect this to hold true over long periods of time.
? The market is pricing in interest rate hikes due to inflationary pressure from demand factors such as currency weakness and a higher oil price. We believe external factors such as these should be discounted in favour of South Africa’s weak supply-side factors, highlighted by low growth and high unemployment. We expect rates to remain stable barring further evidence of inflation, but we acknowledge that the Reserve Bank’s commentary contradicts our view.

The Fund continues to invest with a bias towards longer-duration fixed assets that benefit from the steep money market yield curve. Shorter-dated Treasury bills were bought at attractive yields following Treasury’s decision to increase issuance size.

Commentary contributed by Mark Dunley-Owen

Global and local uncertainty remains elevated. Money market investments offer a relative safe haven in this environment, and the Allan Gray Money Market Fund has outperformed many higher-risk alternatives over recent years. More importantly, the Fund has delivered absolute returns materially higher than inflation, and consequently the real wealth of our clients has grown. The Fund has benefited from a trifecta of low and stable inflation, high money market yields offered by banks for regulatory reasons, and poor performance by higher-risk asset classes. Risk assets such as equities and bonds offer increasing value at lower prices, making it unlikely that low-risk investments such as the Fund will continue to outperform on a relative basis. For many clients this is less important than absolute returns. While we can’t predict the future, it seems likely that money market assets will continue to outperform inflation, making them attractive to clients looking to limit risk and maximise income. The market has moved from expecting a rate cut to expecting a rate hike. The rationale appears to be that higher energy prices and a weaker rand will lead to higher inflation. We have a different view and believe rate hikes would be detrimental to an economy that is operating well below its growth potential. There is also reason to believe that the inflationary impact of recent events will be limited, similar to what was experienced following prior rand weakness and once-off events like the recent VAT increase. The reality is that South African consumers and businesses remain constrained and economic growth is materially below optimal. It seems unlikely that rates will be increased in this environment, unless the Reserve Bank is forced to react to external shocks. The Fund continues to favour longer duration fixed assets that benefit from the steep money market yield curve. Floating rate exposure was added at the start of the quarter due to favourable pricing. Investments were subsequently skewed towards fixed rate exposure as yields rose due to increased global uncertainty. Commentary contributed by Mark Dunley-Owen

It has been good to be invested in money market funds over recent years. The Allan Gray Money Market has returned 7.5% per annum over the last three years, compared to 5.1% from the JSE All Share Index and 5.5% inflation.

The South African Reserve Bank (SARB) lowered short-term interest rates by 25 basis points in March. Monetary Policy Committee members were divided on this decision, suggesting further rate cuts are unlikely. Keeping rates at current levels makes sense in the context of the SARB’s mandate to target inflation between 3% and 6%. February consumer price inflation was 4%, and is expected to increase due to higher VAT, energy prices and wages.

A counter argument is that overly tight monetary conditions are restricting the South African economy. The most noticeable indicator of this is that real GDP growth is barely positive - far below the level needed to address the country’s financial challenges. Similarly, the real lending rate is high, approximated by the 10% prime rate minus 4% inflation. It seldom makes sense to borrow money at a 6% real yield unless one expects similarly high real growth. South Africa does not have this luxury and, as a consequence, private borrowing in real terms is at the same level today as it was three years ago. Constrained borrowing means constrained investment, increasing the likelihood of continued low growth.

The market is currently pricing in a 65% chance of one further 25 basis point cut over the remainder of the year. If our view of tight monetary conditions is correct, it would not surprise us if the SARB cuts rates more aggressively than the market expects. This should be positive for the economy, but lower yields would imply lower future money market returns. With this in mind, we continue to manage the Fund with the maximum allowed maturity and coupon days.

Reinvestments over the quarter were targeted towards one-year instruments at attractive real yields.

Commentary contributed by Mark Dunley-Owen

For much of the last year, the Fund generated better returns than higher risk equities and bonds. This is unusual, and suggests a combination of abnormally low risk returns due to high uncertainty, and attractive money market returns.

The low returns from risk assets were reversed following the market’s interpretation of the outcome of the ANC conference in December, resulting in the FTSE/JSE All Share and All Bond Indices outperforming the Fund by year-end. While recent events are positive, we expect it will take some time for the new ANC leadership to reverse South Africa’s structural decline. Lower risk assets such as the Money Market Fund offer reasonable value in this scenario.

The Fund’s one-year return was 3.4% higher than inflation, meaning investors’ real wealth increased despite them taking little risk to do so. Falling inflation partly explains the Fund’s attractive real return, a trend we expect to continue following recent rand strength. Another contributing factor is the willingness of borrowers, particularly banks and the South African government, to pay up for money market funding. This has kept the money market curve steep, with oneyear instruments offering a material yield pickup versus cash. The Fund remains positioned near its maximum maturity to benefit from this.

A notable change over the recent quarter was that shorter duration treasury bills offered yields higher than equivalent maturity bank NCDs. It is unusual for sovereign risk to be priced higher than bank risk. The Fund took advantage of this opportunity by buying 6- and 9-month treasury bills at higher than 8% yield. The Fund’s exposure to the SA government had increased to 10% by quarter end.

Commentary contributed by Mark Dunley-Owen