BONDS, GOVERNMENT BONDS
Abri du Plessis, Portfolio Manager
Reuben Beelders, Chief Investment Officer
Our multi asset funds, Gryphon Prudential Fund and Gryphon Flexible Fund, are currently heavily exposed to South African government bonds. As a result, they currently offer a running yield, (i.e. interest income per annum), in excess of 10% p.a.
Based on prospective returns offered by other asset classes, we currently consider South African bonds to offer the best risk-adjusted value.
Nevertheless, for the month of March 2021 returns from SA bonds were down 2.5%. Because of our exposure to the long end of the bond curve, we suffered a return of -2.9%.
WHAT CAUSED THIS NEGATIVE RETURN?
Globally, investors are very concerned about inflation picking up. An increase in inflation has the effect of increasing bond yields and this impacts negatively on the price of the bonds.
Stimulus packages implemented by global central banks and the U.S. Government ($0.9trn in December, $1.9trn in March and a further proposed $2trn later this year) has spooked global bond markets resulting in a sell-off in global bonds. The concern is that these stimulus packages will be the catalyst causing inflation to rear its ugly head. SA Bonds have been tarred with the same brush.
WHAT TO EXPECT GOING FORWARD?
The degree to which South African bonds tracked US bonds can be clearly seen in the graph below:
While this ‘mirroring’ may seem to be a logical and predictable expectation to some, our perspective differs somewhat.
At the beginning of March 2021, the yield offered on generic 10-year South African bonds was 9.2% while US 10-year bonds offered 1.4%. The spread between the two, (i.e. the SA bond yields minus US bond yields) was 7.8%. This is a sizable spread and can be attributed to South Africa’s weak fiscal position, poor growth prospects, and structural rigidities not being addressed adequately by government.
However, in the course of the month, SA bond yields rose from 9.2% to 9.7% and US bond yields rose from 1.4% to 1.7% , resulting in an even wider spread of 8.0%.
This implies that South African bonds became more risky at the end of March than they had been at the beginning of that month.
We have a more moderate perspective for the following reasons:
- South Africa’s fiscal position is not great, but it is looking slightly better than it did in September 2020;
- That said, South Africa’s fiscal position has not deteriorated whereas the fiscal position of many other countries, both emerging and developed markets, has;
- Some progress is being made to curb corruption and establish accountability for those responsible;
- There has been some improvement in the energy supply situation in the country.
- Due to better than expected income collection by SARS, it was announced that weekly bond issues would be reduced from the end March. This effectively reduces the “supply” of bonds into the market and creates a better demand/supply balance.
While none of the above are guaranteed quick-fixes and thus the panacea to all our problems, we believe that they are important steps in the right direction.
SO, WHY NOT EQUITIES NOW?
Considering equities as the alternative asset class we are of the view that, from current levels, equities do not offer better risk-adjusted value than bonds. We would contend that South African bonds find themselves in a similar position to that of previous market crises whereby global investors take advantage of the great liquidity of South African bonds to reduce their exposure to emerging market bond markets generally.
In our recent article Are We There Yet, we offer further detailed insight into our concerns regarding equities.
WHERE IS THE COMFORT IN BEING DOWN?
While no fund manager finds joy in a down month, this is the natural order of things. The Gryphon multi asset funds offer investors uncorrelated performance to that of their peers. Over the last 12 – 18 months the multi asset funds have moved against trend and delivered stellar returns as a result of the differentiated underlying holdings. Now, with broad category performance moving upward, again, as a result of the significant difference in the underlying holdings, our funds should be expected to deliver counter-performance.
Investment returns are not delivered in a straight line and pullbacks of this nature are to be expected. Furthermore, one should bear in mind that bonds are still considered a ‘risky asset’, just less so than equities at this stage from our perspective. As equity holdings will dip and soar, so it is with all risk assets. Our comfort and confidence is in our philosophy of rules-based investing; we depend on our data-based indicators to signal an asset allocation shift – sentiment and fear are not a reason to move.
The table below illustrates the difference in returns delivered by the main asset classes: equities, bonds and cash compared to Gryphon’s Prudential Fund. It provides a valuable lens through which to view the difference in the performance journey with equities delivering higher highs and lower lows, as should be expected.
The reason we share this table is to illustrate the behavioural and return differences between equities and bonds. Bonds are much less likely to be negative over a 12-month period than equities. In simple terms, 68% of the time bonds will experience a rolling 12-month return of between 3.77% and 18.03% whereas equities can be expected to deliver somewhere between -3.05% and 34.69% over the same period – a far broader spectrum. And so, while we are not averse to taking on some risk, given the concerns mentioned earlier regarding equity markets currently, our preference is to have our risk exposure in bonds.
SO WHAT NOW?
Given our concern about the volatility and high levels of uncertainty in markets, we have made two significant changes to our holdings. In order to de-risk the portfolios, we have taken advantage of a buying opportunity and added precious metals to both portfolios. Furthermore, we have taken advantage of some Rand strength and taken a 30% exposure to the Swiss Franc. Although we are restricted by regulation to 30% offshore, we consider that the exposure to precious metals offers additional hedging against Rand depreciation.
* Standard deviation is a number used to tell how measurements for a group are spread out from the average (mean or expected value). A low standard deviation means that most of the numbers are close to the average, while a high standard deviation means that the numbers are more spread out. ~ Simple English Wikipedia