Abri du Plessis, Portfolio Manager
Reuben Beelders, Chief Investment Officer
18th May 2021
“This long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.”
~ John Maynard Keynes
Over the past 13 months, the Gryphon multi asset funds have undoubtedly met their objective: to protect investors’ capital in order to make inflation-beating returns more likely.
This was done by preserving capital during the market slump triggered by the COVID19 crisis in March 2020, and then taking advantage of the attractive yields delivered by SA government bonds bought when South Africa was downgraded by international rating agencies.
While we did reasonably expect bond yields to grind lower over time, as detailed in our client communication at the beginning of April 2021, this view was based on the following factors:
- South Africa’s fiscal position is not great, but it’s looking slightly better than it did six to twelve months ago;
- While the fiscal position of many countries, both emerging and developed, has deteriorated, South Africa’s fiscal position has not;
- Some progress is being made in curbing corruption and establishing accountability for those responsible;
- There has been some improvement in the energy supply situation in the country.
Now, 6 or so weeks on, there has been further progress on all of the abovementioned factors.
In addition, our currency has strengthened beyond expectation, from around US$14.90 to US$14.00, which we attribute to the significant rise in commodity prices.
Yet, despite these improvements, including the considerable strength in the Rand, we find ourselves in a position where the underlying drivers of bond yields have all moved in favour of lower bond yields, but there has been no corresponding reaction in the bond market.
One critical factor thwarting stronger local bond yields may be the pick-up in U.S. bond yields.
Our assessment of enhanced risk recognises three sources:
- The low base effects as result of a pandemic-induced slowdown in Q2 of 2020 now make it more than likely that inflation will surprise on the upside. Upside surprises in inflation are not good news for bond investors.
- We continue to see risk in the economic projections currently baked into asset prices. We see most asset classes and commodity prices globally as “priced for perfection” with very little margin for error.
- Central bankers, particularly those in the U.S. appear to want to “have their cake and eat it…and not get fat” ; on the one hand they tell the market that they are prepared to tolerate higher average levels of inflation yet, on the other hand, they want to calm the market by claiming that the current elevated levels of inflation are transitory. While this may work in the long run, Central Bankers have painted themselves into a corner. The risk of policy error and an unpleasant surprise for the market is high.
Historically, South African bonds have sold off at the first sign of risk aversion and our concern is that history will repeat itself and they will do so again.
While South African bond yields are currently high in absolute terms, there is a strong likelihood that the risk-adjusted returns delivered will be below those offered by cash. Our focus on protecting investors’ real value cautions against maintaining this long position in bonds; hence our move to cash.
We also considered and questioned inflation-linked bonds as an investment option but maintain the view that the risk of a blowout in inflation-linked yields is as likely and will be as damaging as the risk in nominal bonds.
So, all options considered, our investment decision is to move into cash; local and Swiss Franc cash. This move, together with the funds’ position in precious metals, illustrates our view of de-risking in mitigation of this stage where markets/risky assets (including the Rand) are priced for perfection.
While mindful that cash is currently a low-yielding asset, it offers investors downside protection. This decision supports the objective of the multi asset funds which is to protect investors’ capital in order to make inflation-beating returns more likely. It also means we keep our powder dry to be able to take advantage of opportunities which can appear suddenly in volatile markets like these.
In the words of John Maynard Keynes,
“When my information changes, I alter my conclusions. What do you do, sir?”