Fund review

The fund delivered good performance for the quarter, bringing the one-year return to 10.4%. We cut the fund’s property position to zero, as sector fundamentals continue to deteriorate. We decreased the allocation to inflation-linked bonds and increased allocations to nominal bonds, as inflation remained benign. The fund’s modified duration was increased from 1.6 years to 2.9 years to reflect our constructive nominal bonds views. The size of the fund was R2.5 billion at the end of the third quarter.

Market overview

Ongoing global trade tensions continued to affect confidence negatively in Q3 2019, putting further strain on emerging market assets. The rand was on the back foot, losing about 6% against the dollar, while the 10-year benchmark government bond was almost 20 basis points weaker at the end of the quarter. The global backdrop still remains supportive for emerging market bonds due to an increasing number of negative-yielding bonds in developed markets and lower-trending inflation globally. The US Federal Reserve cut interest rates for the first time since the financial crisis, indicating that these are midcycle cuts to provide “insurance” against weaker growth rather than a longer-term policy change.

The Fed’s cuts have encouraged emerging market central banks, including the SARB, which are facing declining inflation and slowing growth, to follow suit. This provides further support for emerging market yields to perform well despite the volatility driven by the US/China trade war. SA’s headline inflation moderated to a low of 4% y/y in the quarter and is expected to average 4.2% for the year. The SA government issued a eurobond that was over-subscribed, raising $5 billion instead of the $4 billion that was planned initially. This will go a long way towards improving the government’s funding requirements ahead of the MTBPS late in October. There has been some compression in the yield curve as the government is not considering any more switch auctions for this calendar year, which eases pressure in the ultra-long end of the curve with issuances.

At a conference held in SA in September, Moody’s stated that SA’s fiscal deterioration over the past decade has been in line with the median Baa3 countries. This improves SA’s prospects of avoiding a downgrade, with the worst-case scenario being an outlook change from stable to negative. Moody’s sees the structure of SA’s debt as having lower refinancing risk than its peers. The South African CDS spread is trading wider than comparable peers that are already in junk territory, meaning that the markets have already priced in a downgrade to junk status. A reprieve by Moody’s would give SA an opportunity to produce a credible economic restructuring plan to deal with its persistent fiscal slippage and stimulate economic growth prospects. If there is no downgrade, this will be positive for the bond market.

Looking ahead

With survey data in the US and eurozone continuing to indicate a slowdown in growth, coupled with dim growth prospects locally and inflation firmly inside the target
range, local bonds are still expected to offer attractive returns given their compelling real yields in comparison to peers. The wider currency and credit risk premiums built
into bond prices are expected to gradually unwind after the October MTBPS and Moody’s rating announcements. Globally, the ECB will resume its open-ended quantitative
easing programme in the fourth quarter and the Fed is expected to continue cutting interest rates to manage the slowdown in the US economy. This leaves room for the
SARB to cut rates in November.