Opportunities in Fixed Income
PSG Asset Management has been allocating client capital over the various interest rate curves that have presented high real yield opportunities. They are still finding value in the one-year and longer-dated areas of the money market curve, but are finding fewer opportunities in the front end of the government bond curve and have reduced these positions in their portfolios.
The asset manager has selectively participated in bank and state-owned enterprise credit issues, where they found attractive credit spreads relative to their fair value criteria.
“However, we are turning more cautious on credit names as spreads continue to decline. We have no exposure to the credit of listed property companies because their credit spreads trade below our calculations of fair value,” said Ian Scott in a review of the first quarter of this year. Scott is Head of Fixed Income and Fund Manager at the firm.
These moves are against the background of equity market volatility, which rose sharply in the first quarter of 2018, contrasting starkly with the extraordinarily benign conditions of 2017. Global equity indices have mostly given back gains after a strong start to the year. The MSCI World Index lost 1.1% over the quarter, the FTSE/JSE All Share Index lost 6% and the S&P 500 Index lost 0.8%.
Declines in US equity markets coincided with an across-the-curve rise in US interest rates: the US 10-year bond yield has risen by 40 basis points in 2018 to the current level of 3%.
“Rising developed market interest rates could pose a test to global asset prices that have been underpinned by very loose monetary conditions, particularly if we witness the return of inflationary pressures,” Scott said.
Due to the dramatic improvement in the domestic governance outlook, the rand continued to strengthen in 2018, extending the trend that started in November last year when it traded at R14.50 to the US dollar. This staved off a sovereign bond rating downgrade and provided the South African Reserve Bank (SARB) with ammunition to cut rates by 25 basis points in March.
Consequently, South African government bonds have performed well in 2018: the All Bond Index returned 8.1%. In contrast, the domestic listed property sector had a tough quarter, losing 19.6%. This was largely as a result of the troubles within the Resilient stable, which had a very high weighting in the index.
Following recent bouts of extraordinary and unconventional monetary stimulus – including zero interest rate policies, negative real yields and quantitative easing (bond buying by central banks) – Scott said PSG Asset Management is starting to witness the unwind of accommodative policies globally, and the potential impact on local cash and government curves.
The local backdrop changed dramatically for fixed income and cash investors over the last quarter. In addition to signs of stricter governance, a fiscally prudent budget delivered in February and an improved outlook from ratings agency Moody’s have contributed to a more positive environment for local fixed income markets. Recent tax increases (especially in VAT) are good news for the bond market, as higher taxes reduce government’s borrowing needs in local capital markets.
“We have seen National Treasury reduce the weekly supply of bonds to the market by a third. This is good news after the high borrowing levels seen over the last few years to fund the budget deficit.
“We continue to believe that the domestic fixed income market offers attractive opportunities, especially longer-dated government bonds. Even after the recent decline in domestic bond yields, we expect attractive real returns given our constructive outlook for domestic inflation and improved levels of governance,” said Scott. The SARB’s Monetary Policy Committee remains hawkish in its outlook, despite the recent reduction in the repo rate, keeping real (above-inflation) rates at attractive levels for investors in fixed income instruments.
