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In search of yield in a negative real interest rate environment

13 March 2012 Ryan Adams - Glacier by Sanlam
Ryan Adams - Glacier by Sanlam

Ryan Adams - Glacier by Sanlam

The title of this article is an extremely important investment consideration faced by investors who draw a regular income. This coupled with an aversion to capital loss or heightened volatility complicates the decision making process. The balance between

According to the Association for Savings and Investment South Africa (ASISA), 2011 was the toughest year in terms of inflows for the last six years. Challenging economic conditions in the form of rising costs of living and high consumer debt were notable factors that affected growth in the collective investment industry. New inflows amounted to R45-billion in 2011 compared to R101-billion in 2010 (a reduction of 55%) and R90-billion in 2009, to give some context.[i]

What is interesting to note is that despite the reduction in inflows there has been a general move from the lower yielding risk free assets to more aggressive categories. This is most notable in terms of the Money Market funds where R21-billion flowed out compared to inflows of R30-billion on average over the preceding 5 years when “cash was king”. This is plausible because nominal cash yields, although positive, have been falling to the point where investors are experiencing negative real returns from Money Market investments. This can be seen from the graph below which illustrates annual inflation relative to the STeFI composite index. The STeFI composite gives you an indication of how Money Market funds have on average performed. (Source: INET)
(Click on image to enlarge)

In addition money flowed into the Fixed Interest Income and Fixed Interest Varied Specialist (FIVS) category which attracted roughly R8-billion and R7-billion respectively. This can be indicative of investors requiring higher yielding funds in order to sustain their income levels and/or prevent them from eroding their capital. Important to note is that as investors seek higher yielding assets (moving from Money Market to Fixed Income to FIVS), they are moving higher along the risk spectrum as managers need to generate a higher return. In addition, the mandates in the latter category – especially - are quite broad in nature. Against this backdrop it is not only critical to understand your client’s income requirements and risk appetite but to understand the funds included in their portfolio.

The FIVS category is interesting because of the different strategies asset managers employ in order to generate returns above cash, whilst at the same time trying to preserve capital. These funds invest across cash, nominal bonds, inflation-linked bonds, property and preference shares. Some fund’s mandates also allow offshore exposure which may or may not be hedged against currency risk. As a result this investment category does observe more volatility because of the riskier asset classes included in these funds and from time to time drawdowns may be experienced.

This can be demonstrated in the graphs below where we observe the annual rolling returns (in the first graph) of selected FIVS funds relative to the average Money Market fund. The second graph illustrates their drawdowns.
(Click on images to enlarge)

In summary, investors drawing a monthly income whose investment portfolio is relatively conservative may require an additional yield pick-up to sustain their income levels. Therefore it is important to consider funds that are managed using the full spectrum of fixed income asset classes in order to derive the maximum yield while limiting the downside and producing superior risk-adjusted returns.

The Monetary Policy Committee’s (MPC) concern about economic growth - both locally and internationally as well as inflation continuing to be driven by cost-push factors may result in interest rates remaining lower for longer. If inflation continues to trend upwards, the resultant effect could be that negative real rates become more pronounced. But as shown above there are investment managers out there who are seeking opportunities to enhance yields.

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[1] ASISA statistics: http://www.asisa.co.za/


 

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