STANLIB Flexible Income Fund: Agility and skill to deliver your income needs

The outlook for fixed income remains volatile but we are at the turn in the rate cycle. The party will be in bonds for the rest of this year.

Sylvester Kobo

Deputy Head of Fixed Income

Key takeouts

The STANLIB Flexible Income Fund is the ideal steward of investors’ capital in today’s volatile fixed income environment.
The Fund’s mandate allows our portfolio managers to invest in a broader set of building blocks than many of their peers, improving their ability to position the fund for conditions throughout the cycle.
The Fund allocates more actively than its peers; this ability to deviate from the crowd has been a major factor in the Fund’s outperformance over time.
The Fund is an excellent alternative for clients who wish to move incrementally up the risk/return curve from money market and income fund strategies.
For investors who are pre- and post-retirement, the Fund offers bond-like returns but with less volatility and a focus on preserving investors’ hard-earned capital.
Investors in the Fund benefit from STANLIB’s dominant position in South African fixed income, the experience and diversity of our portfolio managers and their access to global insights through STANLIB’s strategic partnership with J.P. Morgan Asset Management.

2023: The Party Is Still In Fixed Income

On Tuesday 22^nd August we hosted a webinar to update our stakeholders on STANLIB’s view of the fixed income environment with a particular focus on the STANLIB Flexible Income Fund.

The webinar took the form of a Q&A session between Sylvester Kobo, co-manager of the Fund, and Henry Munzara, STANLIB’s Deputy Head of Investments.

Fixed Income Today: Still Volatile But The Cycle Has Turned In Our Favour

It should come as no surprise that a decade of zero interest rates followed by a tsunami of inflation and the steepest rate hiking cycle in memory have created unprecedented volatility in fixed income markets over the last year. Happily, higher rates seem finally to be cooling inflation and growth; markets are pricing in an end to the Fed’s rate hiking cycle.

It may be consensus that we have seen the last hike from the Fed in this cycle but the expected pace of future rate cuts is a moving target as the market tries to anticipate the Fed’s response to mixed data. The most popular measures of US inflation might be cooling, but employment has remained firm and growth appears to be reaccelerating: Citigroup’s US economic surprise index is at its highest level since early 2021. Three months ago, the market was expecting the Fed to have cut its funds rate by 230 basis points by the end of 2024; today the curve is priced for only 100 basis points of cuts by that time. The yield on the 10-year Treasury dipped to 3.3% in April but has subsequently backed up to 4.25% today, a level not seen since before the Global Financial Crisis.

We agree that core US inflation is uncomfortably high but mainly due to the ‘shelter’ component which the San Francisco Fed thinks will reverse over the next six months. Non-farm payrolls were weaker than expected in July and the June reading for core CPE reading, the Fed’s favourite measure of inflation, hit its lowest level since October 2021. Overall we are happy that US inflation is peaking, that growth will cool and that there is good value to be found in US debt at these yields. The Fund has been able to take offshore exposure since 2019 and today the portfolio managers can lean on the world-class intellectual resources of J.P. Morgan Asset Management, STANLIB’s strategic partner since 2022.

Where the US leads the world follows, so the prospect of lower rates in the States is good news for fixed income investors everywhere else. SARB Governor Letsetja Kganyago’s publicly commented at the Jackson Hole central bankers’ conference that there is more work to be done on inflation and that a weak Rand is itself a threat.

Nevertheless SA inflation has turned the corner: the day after the webinar, headline consumer inflation for July was confirmed to be 4.7% year-on-year, down from 5.4% in June. This was a faster deceleration than expected and the 10-year SAGB duly rallied. SAGBs are already offering some of the highest real yields in EM and we see no reason why the SARB would not be able to cut rates by up to 150 basis points by the end of 2024.

SAGB investors are also in position to benefit from an improvement in two perceived local risks which have been weighing on debt and currency markets.

Firstly, Russia. Actively courting the Putin regime has exposed SA to the risk of being excluded from the US’ African trade programme (AGOA) which accounts for 25% of SA’s annual exports. The timing couldn’t be worse since AGOA’s renewal is being considered by Congress but the recent South African delegation to Washington appears to have smoothed the issue over.

Secondly, loadshedding. Last week Eskom announced that the three units at Kusile could become operational ahead of schedule. One unit was planned to be back online at the end of November 2023, with the remaining two units back up in December. The group said it now sees the potential for at least two units to be back up by mid-November, with the final one following in December.

Since our last webinar in March we have increased our allocation to offshore bonds and cash, where a 9% yield is very attractive on a risk-adjusted basis; at the same time we have cut our exposure to floating rate credit instruments which have done so well for the fund over the last 12 months.

About the STANLIB Flexible Income Fund

STANLIB is the largest fixed income asset manager in SA. The STANLIB Flexible Income Fund leverages the firm’s resources to offer our clients sophisticated, active tactical asset allocation across all classes of income-generating securities in SA and offshore. The fund is an important part of STANLIB’s market-leading range of fixed income products.

Source: STANLIB

The Fund’s official benchmark is 1.1x the total return of the STEFI Composite Index which tracks the returns available in the South African money market.

While the Fund was established April 2004, the appropriate period to evaluate its performance is from January 2020 when the Fund adopted a new strategic asset allocation framework which reduced exposure to property and added offshore exposure. Since then the Fund has delivered on its mandate, with a total gross annualised return of 9.2% over the 36 months to the end of June 2023 versus STEFI’s 5.5%.

The STANLIB Flexible Income Fund’s mission is to protect and grow investors’ capital by allocating more actively than its peer group across the entire spectrum of income-generating asset classes in SA and offshore.

The fund’s mandate allows its managers to invest in fixed income securities of any maturity issued by governments, state-owned enterprises, municipalities and companies. The fund’s managers can therefore protect and grow investors’ capital by identifying mispricing of various types of security as well as by changing the duration of the portfolio, as is demonstrated by the positioning across asset classes below.

Each asset class is a potential source of return for the fund; the following chart shows how they have driven the fund’s performance over one, three and five years.

The Fund’s philosophy of active management is demonstrated in the following chart which shows the fund’s modified duration and the yield on the R186 SA Government bond.

Liquidity

Truly active allocation demands liquidity within the portfolio. The STANLIB Flexible Income Fund’s managers therefore maintain a strict discipline of only investing in liquid assets so they can rapidly change the fund’s allocations when required.

The fund’s holdings in SA government bonds are concentrated in issues with maturities between three years and seven years, the most liquid part of the yield curve. To gain access to credit, a less liquid asset class than sovereign bonds, the fund allocates to STANLIB’s Income Fund and Extra Income Fund, both of which offer daily liquidity.

In a nutshell, if you’re looking for truly active management and top-quartile, inflation-beating returns with capital protection, consider the STANLIB Flexible Income Fund.