Finding income, growth and protection of capital during unusual times
In a world of uncertainty, rising inflation, low interest rates, high liquidity and rising government debt – how do we generate income growth and capital protection from our multi-asset income fund?
- Volatility and uncertainty continue to define the current market environment, while a backdrop of sustained low interest rates created by unprecedented central bank intervention means investors are seeking income strategies that deliver higher returns (than cash) while minimizing risk as much as possible.
- STANLIB’s Flexible Income Fund has been designed to ensure clients are able to benefit from active allocation by a highly experienced team across fixed income instruments and income-generating growth assets, both locally and offshore.
- The fund is currently positioned to consider the opportunities and risks we see in the South African and global markets including transitory inflationary pressures and interest rate expectations. South African asset pricing could potentially benefit over the longer term from the current strong cyclical performance and potential reforms, however short term risks remain in play.
- While we favour local fixed income assets over their offshore counterparts, we remain neutral on risk and well diversified, given the uncertainty in the market and the unusual cycle. A continued accommodative stance will support domestic economic growth while reform and progress in addressing corruption are attractive to foreign investors. We are mindful, however, of the recent unrest and the potential impact this could have on SA’s ability to drive economic growth.
Volatility and uncertainty continue to define the current market environment, while a backdrop of sustained low interest rates created by unprecedented central bank intervention means investors are seeking income strategies that deliver higher returns (than cash) while minimizing risk as much as possible. Multi-asset income funds continue to be an attractive investment choice in the South African market as many investors opt to take on additional risk and “move up the yield curve” in search of higher income and returns.
STANLIB’s Flexible Income Fund has been designed to ensure clients are able to benefit from active allocation across fixed income instruments and income-generating growth assets, both locally and offshore. Towards the end of 2019 we refined the fund’s strategic asset allocation guideline to include additional asset classes. This has enabled us to optimize portfolio construction to better meet the fund’s objective. The fund’s allocation to offshore bonds, South African inflation-linked bonds and listed property provides additional opportunities to capture growth and complements an allocation to local fixed income assets. Over the last year we have specifically benefitted from an allocation to offshore bonds managed by our long term global partner, Brandywine. Innovative thinking and dynamic active allocation during these uncertain times remain critical to capture available returns, while limiting downside risk.
Asset allocation: optimised for neutral risk
STANLIB’s Flexible Income Fund is currently positioned to consider the opportunities and risks we see in the South African and global markets. The social unrest that has gripped the country over the last weeks will undoubtedly have a devastating impact on our economy over the longer term. At this point in time, our asset allocation continues to reflect our broader views around interest rates, building inflationary pressure and South African asset pricing which could potentially benefit over the longer term from the current strong cyclical performance and potential reforms.
Inflationary pressures and increasing rates
Inflation pressures are rising globally, and as a result markets are beginning to price the risk of SA interest rate hikes happening sooner than previously anticipated. We believe the interest rate hikes this year by our EM peers are warranted, given their inflation pressures, but that is not the case for SA.
As seen in the chart, three rate hikes by the Brazilian central bank resulted from significant inflation pressure. South African inflation has been marginal in comparison. It is also worth noting that one third of South Africans are unemployed, and this level will likely rise as a result of recent social unrest, so we believe it would be foolhardy for the South African Reserve Bank (SARB) to materially increase rates in the near future.
Inflation in the US is way ahead of the US Federal Reserve’s previous 2% target. We have pared back on risk to offshore bonds as a result, but we think the Fed has learned from the taper tantrum of 2013 and will carefully remove monetary stimulus. We expect messaging of this nature into the market over the next few months, with tapering to start early in 2022. This provides further space for the SARB to hold off on hiking rates until next year.
We think markets are unfairly pricing in aggressive SARB rate hikes. We expect the first hike in the first quarter of 2022 with a total of two hikes over the year. This is favourable for SA income assets.
To reflect this view, we have closed our underweight position in inflation-linked bonds and switched out of fixed notes into floating notes (about 40%) to reflect the inflation and resulting interest rate risks. We remain relatively neutral on our positions, with no “big bets”.
Favouring SA assets over offshore
A persistent trade balance surplus in SA is providing a cyclical boost to the economy, primarily due to the commodity sector’s outperformance. This has been supported by a stronger rand. Actions around corruption and the recent announcements around reform are also structurally very positive for the country. These actions demonstrate the seriousness of the South African government to address issues that have been holding back much-needed economic growth. Acknowledging that, the chart below reflects views prior to the recent and tragic social unrest. It shows 49% of foreign respondents indicating that energy reform will encourage an increase in their allocation to SA.
Further to these insights, we note that foreigners are currently holding the highest level of South African bonds on record in rand terms. Prior to the Moody’s downgrade in 2020, foreigners owned approximately R820 billion of local bonds. This level dropped to approximately R730 billion following the Moody’s credit downgrade of SA as a sovereign, but it has recently climbed back to R850 billion.
We expect good returns for the SA bond asset class as a result of improved confidence –despite the recent social unrest across the country. We reduced our allocation to offshore assets in favour of our local allocation.
Neutral risk and portfolio duration
Our philosophy of staying close to markets combined with our deep experience in managing duration risk means we nimbly and actively adjust our modified duration as markets shift. We recently moved to a relatively neutral duration stance for the portfolio. While as stated above, we hold a positive investment case for SA assets including SA bonds – we recognize the risks of investing across the yield curve. Additional environmental risks such as low vaccination rates in SA and the third wave of Covid-19 across the country need to be considered. Importantly, social unrest will add further risk. While it was sparked by Zuma’s arrest, the resulting and mostly opportunistic looting was a culmination of many factors, including income inequality and a weak police system. We believe swift action from government to prevent further events of this nature will soften the market impact.
SA listed property adding growth
Growth assets are an important contributor to portfolio returns and importantly we remain active in allocating to select asset classes when opportunities arise for this fund.
Valuations in the South African listed property sector have been very attractive and we invested from February 2021 to May 2021 when we believed the sector had reached fair value.
Given the sector did not experience the expected sell-off from the impact of further lockdowns, we resumed a 5% allocation in late May. Malls and shopping centres have clearly been severely impacted by looting. Our listed property team confirms that the majority of areas impacted were community shopping centres and CBDs. Listed property companies own a limited portion of this market and where they do, property owners are well insured.
Consistent inflation beating performance
Performance over the last year has been strong and largely driven by the active nature of our portfolio management and the ability to find opportunities at the right risk levels.
Stay close to markets, stay nimble
While we favour local fixed income assets over their offshore counterparts, we remain neutral on risk and well diversified, given the uncertainty in the market and the unusual cycle. A continued accommodative stance will support domestic economic growth while reform and progress in addressing corruption are attractive to foreign investors. We are mindful, however, of the recent unrest and the potential impact this could have on SA’s ability to drive economic growth.