18 months ago, the Money Market Fund commentary began with a quote from a Talking Heads song highlighting that nothing had changed. Current times could not be more different. The COVID-19 pandemic has affected all our lives. It has also negatively impacted the prices of many investments.

Very low risk unit trusts, including money market funds, tend to excel in unsettled environments. The Allan Gray Money Market Fund aims to protect your capital and provide a reasonable level of income. It has done a good job of meeting this objective over recent years, and we believe it will continue to do so amidst current uncertainties. A summary of what you own in the Fund highlights why.

The Fund is invested in a basket of low-risk debt securities. Using round numbers, 75% of these are short-term, senior funding to the large South African banks. These are well capitalised, profitable and have survived extreme scenarios before. 15% of the Fund is invested in government treasury bills, arguably the safest rand-denominated investments available. The remaining 10% is funding to high-quality companies such as Shoprite and Sanlam.

Despite its low risk holdings, the weighted average yield of the Fund is 7.1%, comfortably higher than inflation. Unfortunately, it is unlikely to remain this attractive indefinitely. Now more than ever, the South African government needs to stimulate growth and reduce the cost of the country’s high debt burden. The South African Reserve Bank lowered interest rates by 100 basis points in March, and is expected to lower them further in the near future. This, plus possible inflation from a weaker currency and global fiscal stimulus, may reduce the real return offered by money market instruments. While future money market returns are likely to remain suitable for many savers, they are unlikely to match those of the recent past.
Despite the uncertainties and expected headwinds, the Fund continues to offer capital protection and a reasonable income. We continue to manage it with these objectives in mind, and are grateful that you trust us to do so.

The Fund continued to experience inflows during the quarter. These were invested to maintain equal fixed and floating rate exposure. We found opportunities to invest in senior short-dated fixed rate bank bonds at attractive yields relative to negotiable certificates of deposit (NCDs)

In the third quarter of 2019 we spoke about South Africa’s elevated fiscal risks. Since then, Finance Minister Tito Mboweni delivered his Medium-Term Budget Policy Statement (MTBPS) on 30 October. His speech was certainly too honest for the market’s liking, as he chose not to sugar-coat the stark reality that South Africa “stands at the end of winter and the food cupboards are almost bare”. He emphasised that our national debt is increasing at an unsustainable pace, and that government spending should outstrip revenue by R306bn in the 2019/20 fiscal year.

The budget is being cannibalised by interest payments on debt, government wage increases, and bailouts for state-owned entities like Eskom and SAA. Previously promised government wage bill cuts and spending reductions did not bear fruit, with investors frustrated by the perceived lack of effort to rein in our spiralling debt metrics. In this regard, the average wage increase across government was 6.8% in 2018/19, or 2.2% above inflation over that period.

The South African Reserve Bank is in a challenging position when it comes to setting monetary policy. This was evident in its contentious fourth quarter Monetary Policy Committee vote, in which three members favoured rates being kept on hold against two voting for a rate cut. While SA’s headline inflation printed at 3.6% year-on-year in November, its lowest rate since 2011, the committee is concerned about government’s rising borrowing costs and the pass-through effect that this may have on the economy.

What does this mean for money market returns? I

n the panicked aftermath of the MTBPS, opportunities presented themselves for us to reinvest cash into one-year bank paper at slightly elevated yields of 7.70% - 7.80%. Additionally, given expectations of increasing government debt issuance, treasury bill yields rose substantially towards the end of the year. This situation is surely being compounded by a national household savings rate of circa 0% – translating into a stagnant pool of investable assets (or limited “spare cash”) with which to fund the current government revenue shortfall.

Given six-month government bill yields of 7.70% versus six-month bank yields of 7.25% (a 0.45% pick-up), the Fund strategically almost tripled its SA government exposure (from 6.6% of the Fund on 30 September, to 18.5% of the Fund by the end of 2019).