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Fixed income investors should look before they leap

16 April 2021 PSG Asset Management

Recently, fixed income investors have been roiling from the news that one of South Africa’s largest money market funds will be closing its doors to investors.

As a result, many fixed income investors are now forced to explore alternative investment options at short notice. But according to PSG Asset Management Fund Manager, Lyle Sankar, fixed income investors should take stock of their fixed income needs within the context of their entire investment strategy before they leap into the next best option. Given the extreme circumstances we are currently seeing in the markets, now is an excellent time for an advice refresh and a review.

A key challenge for investors re-evaluating their money market investments at this time, is that short-term rates are the lowest that they have been in 55 years. Despite this, there are opportunities to generate adequate income. “We believe the current rates cycle and low inflation outlook makes it harder, but the market still presents compelling prospects for income-seeking investors willing to look through the current noisy environment”, Sankar says. “However, investors who flock into the shorter-dated end of the market, or who ignore material risks in the corporate credit market, are increasing the likelihood of underperforming their income needs.”

There has been unprecedented support for money market and income funds by investors seeking yield as well as lower risk. This has eroded the prospective returns available from the instruments these funds typically use (corporate credit, bank funding curves and cash/cash-like instruments). Conversely, many investors are sceptical about the value in longer-dated nominal and inflation-linked sovereign bonds. Sankar believes the real yields offered by these longer-dated bonds, however, offer significant compensation for the current visible fiscal risks South Africa is facing, and in addition, they still trade at significant higher yields than developed market bonds.

“We have been extremely selective in the fixed income market for a considerable time. Focusing on removing emotion from the decision-making process, across all asset classes, remains central to our process and philosophy, and it has continued to reward our fixed income investors over time,” Sankar points out. There is still opportunity for investors to maximise the opportunities presented by South Africa’s steep and distorted yield curve, and to lock in attractive yields in the near term – but typically, these opportunities are found slightly further along the yield curve. Therefore, these opportunities will not be seen in the typical money market fund.

The key for investors re-evaluating their income portfolios at this time, is in carefully weighing the available fixed income opportunities, and making a decision based on a considered evaluation of the risks. Investors who have longer investment horizons, should also consider whether their current allocations support their long-term investment goals.

Money market funds are a default choice for many investors and have a definite role to play when it comes to generating income. However, the current cycle does not suggest attractive income levels for clients, especially when compared to inflation. There are opportunities available for income investors to generate attractive levels of income at marginal additional risk. Taking a step back now and putting in the effort to critically review whether your strategy has perhaps been too short-term oriented or too conservative, will greatly benefit investors into the future.

“We believe it’s an opportune time for investors to evaluate the positioning in their income portfolios, ideally with the help of a financial adviser, to ensure risks are considered appropriately as part of a holistic approach. Opting to invest at the short-end of the curve will see investors foregoing some of the attractive income options available, and their income expectations are likely to be disappointed. The key will be in being selective about the additional risks you take on, in the pursuit of higher income”, Sankar concludes.

Quick Polls

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Financial behaviour experts suggest that today’s risk modelling methodologies ignore your client’s emotional ability / behavioural capacity. What are your thoughts on spicing up risk profiling tools to make allowance for your client’s financial behaviours

ANSWER

[a] Bring it on; my client’s make too many irrational financial decisions
[b] Existing risk profiling tools are adequate
[c] Risk profiling tools should be based on the model / rational client
[d] The perfect risk profiling tool is science fiction
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