Bond funds are star performers

Bond funds were the worst-performing funds up to 30 June 2008, but have since become the star performers, achieving an average return of 18,6% in just over six months.

South African bonds, which have been in a bear market since early 2006, had a spectacular about-turn in July 2008, according to Dr Prieur du Plessis (pictured), Plexus group chairman. The sharp turnaround in the bond market caught by surprise most flexible fixed interest managers, who are able to change their portfolio compositions aggressively in line with their views on prospects for the fixed-interest market.

According to Du Plessis, there are a number of reasons for the turnaround. “Investec’s announcement that the South African inflation rate was overstated was a complete surprise. Secondly, many market players did not expect the global financial crisis to affect the South African economy to the extent that is now evident and, thirdly, many did not expect domestic inflation to decline as swiftly.”

“Despite their performance, investors should not move from the money market into local or global bond funds now,” says Du Plessis. “The bond market is already discounting a very dismal economic scenario and more short-term interest rate cuts by the South African Reserve Bank.”

He adds that there are, however, several threats that could dampen further rate cuts. “Any more shocks in global financial markets will result in renewed risk aversion and a weaker rand. Secondly, South Africa’s large current account deficit continues to deter foreign investors and, thirdly, the country’s political situation is not helping to induce confidence.”

Arno Lawrenz, chief investment officer of boutique fixed-interest asset manager Atlantic Asset Management, concurs with Du Plessis’ view. “We have increased our exposure to short-dated bonds but remain wary of currency risks in this global risk-averse market,” says Lawrenz.

“A marked increase in government bond issuance due to a future shift to a fiscal deficit, as well as deteriorating government revenue collection, shouldput upward pressure on bond yields, particularlyat the long end, resulting in curve normalisation and capital losses,” says Lawrenz.

Du Plessis’ advice to investors is to stick to flexible fixed-interest funds, where the manager has the freedom to change the composition of the portfolio in accordance with market conditions.

“A cautious strategy towards fixed-interest funds is definitely warranted at this stage,” he says.

Graph A

(Click on image to enlarge)

Source: MoneyMate

Graph A shows the average performance of the domestic fixed-interest sectors over the year ended 30 June 2008.

Graph B

Source: MoneyMate

Graph B shows the performance of the domestic fixed-interest sectors from 30 June 2008 to 20 January 2009.