The importance of a dynamic approach when investing in fixed income markets

Compared to equity markets, fixed income markets tend to be seen as being more placid and predictable (and even, dare we say it, rational).

However, fixed income markets are currently undergoing some pivotal changes that will have material implications for how investors’ portfolios are constructed.

More conservative investors tend to be more reliant on the fixed income assets in their portfolios to help secure the required long-term objectives, including income generation and capital preservation. However, fund managers cannot be complacent and assume fixed income assets will always achieve these goals. As prices change, fund managers must carefully assess the available returns and associated risks, ensuring their clients are being adequately rewarded for these risks, and that overall risks are appropriate.

For PSG Asset Management, not overpaying for assets is a key driver of not only managing risk, but also delivering the returns that help investors achieve their required long-term outcomes. We therefore adopt a dynamic approach in our portfolios, adjusting our preference for assets as prices and risk/return characteristics shift.

Below we explore how shifting market dynamics have led us to adjust allocations in PSG Stable Fund over time, to our investors’ benefit – firstly looking at situations that lead us to lean into market weakness (and buy), and secondly situations that we believe signal over-priced assets (hence prompting sales, or leading to us avoiding investment).

Buying at the right price: Finding value in different areas as market drivers change

Prior to the disastrous Nenegate scandal (when President Jacob Zuma replaced the then Finance Minister Nhlanhla Nene with short-lived appointee Des van Rooyen in December 2015), South African bonds were delivering low real yields. As a consequence, we held relatively little duration in our funds, with minimal exposure to longer-dated bonds. Following van Rooyen’s “Weekend Special”, however, fears around South Africa’s fiscal future intensified. In our view, many of these fears were overblown, pricing in a full-blown default while there was little evidence to suggest that South Africa’s fiscal position would reach such a dire state, even in the medium term. While debt sustainability could be impacted by weakened governance and higher required yields in the long term (all else being equal), the steepening yield curve implied a debt spiral was a foregone conclusion and would occur imminently.

Given our assessment of the situation and what we considered to be low immediate risks to client capital, we started taking on more duration in our funds in early 2016. In the period leading up to Nenegate the South African nominal 10-year yield was below 8% while inflation averaged 6%, meaning bonds offered 2% real yields. In early 2016, real yields available on South African 10-year nominal bonds exceeded 4%, and they have subsequently averaged 4.8% p.a., making them an attractive asset despite concerns about South Africa’s fiscal position.

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