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2020 Investment views

A key year ahead for SA bonds

11 November 2019
Author: Peter KentCo-Head of SA & Africa Fixed Income

Key Takeaways

  • SA bond yields and valuations are still attractive.
  • The overspend by the government needs to be financed from offshore sources.
  • South Africa therefore needs enticing real interest rates to attract foreign investors into our government bond market.
  • We expect higher real interest rates and the positive income environment of the last two years to remain in place.
  • While we are positioned to take advantage of appealing real bond yields, our offshore exposure acts as a buffer against risks.

 

Q&A with Peter Kent on

Diversified Income

Investors have enjoyed a favourable fixed income environment in South Africa. But risks and uncertainties abound – what does 2020 hold for investors?

Q Going into 2019, the SA Fixed Income investment team was bullish about the domestic fixed income space. How has this view panned out?

Our assessment was based on a positive inflation outlook and attractive South African bond valuations – relative to emerging market peers and inflation. This view turned out to be correct. Inflation has remained contained around the South African Reserve Bank’s (SARB’s) mid-point target of 4.5%, averaging 4.3% over the year. Government bonds have provided a generous yield well ahead of inflation (around 9% annualised) and a capital uplift of close to 1%, year to date. Investment-grade credit has yielded a significant amount above cash (approximately 1.5-2%). These yields should be seen against a backdrop of inflation at 4.3%.

Q What does 2020 hold for the South African fixed income market?

Bond yields and valuations are still attractive. While there are local and global risks, we believe the South African fixed income environment will remain favourable for investors seeking an income. Why do we think the income environment will continue to be rewarding?

The mid-term budget once again highlighted the South African government’s propensity to spend more than it earns as a percentage of GDP. Currently, our budget deficit hovers around 5% of GDP. On top of that, our current account, which records South Africa’s transactions with the rest of the world, shows that we are running a deficit of approximately 3-4% of GDP. Essentially, as the value of our imports exceeds the value of our exports, more money is flowing from South Africa to our trading partners than the other way round.

The two deficits are related, meaning the overspend by the government needs to be financed from offshore sources. South Africa therefore needs enticing real interest rates to attract foreign investors into our government bond market. To maintain this fragile equilibrium, the SARB has to keep real interest rates higher than it otherwise would have done. Sustaining this delicate balance has kept the rand from unhinging and inflation under control.

This fiscal predicament is unlikely to be resolved any time soon and therefore these higher real interest rates and the positive income environment of the last two years, will remain in place. However, this is not without its risks.

Q What are the major risks and how are they influencing your portfolio positioning?

A key domestic risk is the state of the fiscus, progress of essential economic reforms, and Moody’s downgrading South Africa’s sovereign debt to below investment grade. This would trigger foreign capital outflows, which could lead to bond market weakness and rand depreciation.

Growth in South Africa is too low. If these economic reforms are not successful, and growth and tax revenues continue to disappoint, South Africa could find itself in a classic debt trap.

Given the credibility of the SARB and weak domestic demand, we are still convinced that inflation will remain under control and stay close to the mid-point of the target band. However, it is possible that if some of these risks are realised, a weak rand could lead to higher inflation.

Key global risks are the US-China trade war and the possibility of a global recession.

Risks and uncertainties abound, but due to the inflation-beating income environment, we believe SA fixed income still offers very attractive opportunities. We have a balance of exposures to provide some protection against the multitude of risks locally and globally. While we are positioned to take advantage of appealing real bond yields, our offshore exposure acts as a buffer should any of these risks arise. This investment strategy has worked well for us during periods where we have experienced bond market volatility or rand weakness.

 

All investments carry the risk of capital loss.

Peter Kent
Peter Kent Co-Head of SA & Africa Fixed Income

Important information

All information provided is product related and is not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Past performance is not necessarily a guide to future performance. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. We endeavour to provide accurate and timely information, but we make no representation or warranty, express or implied, with respect to the correctness, accuracy or completeness of the information and opinions. We do not undertake to update, modify or amend the information on a frequent basis or to advise any person if such information subsequently becomes inaccurate. Any representation or opinion is provided for information purposes only. This is the copyright of Investec and its contents may not be re-used without Investec’s prior permission. Investec Asset Management (Pty) Ltd is an authorised financial services provider. Issued by Investec Asset Management, November 2019.

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