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Flexible fixed income funds look attractive

29 June 2020 Albert Botha, Head of Fixed Income Portfolio Management at Ashburton Investments

In a falling interest rate environment flexible income funds are expected to provide investors with good returns over inflation compared to cash or money market funds over the next 12 to 24 months.

The aggressive interest rate cuts by the South African Reserve Bank (SARB) has reduced the repo rate from 6.25% to 3.75% this year to alleviate some of the economic pain of the COVID-19 pandemic - but it means money market funds are now delivering much lower returns.

In the past few years, the reward for taking on additional risk by moving out of cash or money market funds into flexible income funds – such as the Ashburton SA Income Fund or Ashburton Diversified Income Fund – was low as the difference in returns was minimal.

Now, however, the expected difference in returns between flexible income funds and cash or money market funds will be significant over the next 12 to 24 months.

Money market funds aim to preserve capital by investing in short-term (less than 13 month) securities and liquid debt instruments from a number of banks. Income funds typically hold longer term debt such as local bonds, notes, preference shares and foreign bonds which offer higher yields with the additional benefit of providing diverse sources of returns.

An income fund has more risk than a money market fund but is considered a low- to medium-risk investment as the risk of capital fluctuations over a 12-month period is low, especially when compared to equity investments.

Ashburton’s Income funds are expected to provide returns well in excess of inflation as measured by Consumer Price Index (CPI), which is expected to fall as low as 2% in the next few months and average around 4% in the next 12 months.

The Ashburton SA Income Fund is expected to deliver a nominal return of around 6.5% to 7% a year while the Ashburton Diversified Income Fund is expected to give about an 8% year – or a real return of 4% above inflation.

Investors in income funds will therefore be well rewarded for taking on slightly more risk over the next 12 to 24 months.

In contrast, money market funds are expected to provide nominal returns of around 5% over next 12 months.

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