Malcolm Charles, Portfolio Manager at Investec Asset Management, talks to Lindsay Williams about the fixed income landscape in South Africa and abroad.
Lindsay Williams: The last time I spoke to Malcolm Charles, who is the Portfolio Manager, Fixed Income at Investec Asset Management in Cape Town, he was talking to me enthusiastically about how exciting the fixed income asset class and space was. I never normally associate ‘with excitement’ and fixed income in the same sentence but it seems to me at the moment that fixed income is exciting once more for various reasons. Malcolm Charles is on the line now.
Malcolm, I look at the beginning of the year – new political dispensation, the market very enthusiastic about South Africa. Then there was sort of a wobble, lack of confidence after that initial burst of confidence but suddenly, with various countries coming to South Africa and saying ‘yes, we will invest in your country’, the details need to follow, of course, but again I think fixed income is becoming an asset class that needs to be paid attention to.
Malcolm Charles: Absolutely. I mean you quite rightly said started the year off on a very firm footing, did very, very well, both currency and bonds. Then we had more of a global wobble that the world got very worried about emerging markets; a lot of money flew back to the US; we saw the dollar have a strong rally, and that hurt everyone and SA was one of those countries as well.
We had record outflows but, as you rightly said, the President has been on a bit of a roadshow, sold the country very well and we have seen…I’m not going to call it a rally just yet. There’s good stabilisation and the currency has come back nicely but, yes, where yields are at the moment, very, very attractive on both an absolute level and a relative level, so a good place to be investing at the moment.We had record outflows but, as you rightly said, the President has been on a bit of a roadshow, sold the country very well and we have seen…I’m not going to call it a rally just yet. There’s good stabilisation and the currency has come back nicely but, yes, where yields are at the moment, very, very attractive on both an absolute level and a relative level, so a good place to be investing at the moment.
Lindsay Williams: We are past the mid-year point of 2018. Perhaps you could briefly give us a potted history of what the bond market has done, what the yields have done in South Africa from January right up to today.
Malcolm Charles: So the 10 year bond was trading, just to go back to sort of mid-December, where we were all panicking about the political outcome and the political direction of the country, we were over 9%, close to 9.25. Then Cyril Ramaphosa elected President – bond yields rallied aggressively over 100 bps, giving a fantastic return to the market.
Then in Q2 when Trump started the trade wars, etc., you saw a complete unwind of that, so bond yields back up to above 9%, a sharp sell-off on global fears and now we have seen a reasonable stabilisation and today we are trading around 8.60. So about a third of that sell-off has pulled back, still attractive yields but much more stable and much more positive mood at the moment.
Lindsay Williams: Incredible yields I would say if I was an international bond investor and I suddenly saw what has happened with President Xi and Cyril Ramaphosa in the last few days and looking at that yield that you have just described. When I see the bond market, in my simplistic way, Malcolm, I look at the rand first of all and its weakness or its strength and its recent history, I look at the mood on emerging markets in general and specifically South Africa and then I look at the international bond market itself. The rand, first of all, if we can – the rand is lovely at the moment. It’s lovely and steady.
Malcolm Charles: Absolutely. It has also had a round trip where it got very, very weak going into December, pulled back probably a little bit too much. I think the rand probably got even more euphoric than the bond market did after the ANC conference but, if you look at it against our terms of trade, which is what we export against what we import, we were very cheap in December. We got very expensive February and March and now we are probably fair value and I think that is why it has been relatively stable the last couple of weeks. We are at a level where it is very fair for the current macros of the country.
Lindsay Williams: Okay, so that’s the rand. What about the mood towards emerging markets and also the mood towards South Africa? Again, it has been a bit of a roller coaster in 2018.
Malcolm Charles: A complete roller coaster and I think some of it was probably justified. Some of it was a complete overreaction because I think the positioning was probably too much in emerging markets. If I look at the flows into our market, there were a lot of what we call “the tourists”. They are not really even investors. They woke up in February/March and realised that things have changed in South Africa and came in. So they came in a little bit too late, possibly made the currency and bonds a little bit too expensive and they panicked at the first sign of emerging market jitters. Now that they have gone out, I think those bonds have found much stronger hands. I think they have gone into more longer term investors and I think the market is in a much healthier state.
So bonds, you are getting a yield of 8.60/70 on the R186, which is about an 8 year bond and remember inflation is 4.5. So I mean from a real perspective it is a phenomenal return and, if you look at us against our peers, we have been punished as much as Turkey and Brazil and Mexico and Russia, which I think our macros and our politicians are behaving a lot better than those countries.
So I think on a relative basis there is a lot of value, on an absolute basis it’s a great yield. I think, if you think of what other asset classes are offering you in South Africa, South African bonds are probably one of the most attractive and then, if you look at it relative to inflation, gee whiz, you get a 3.5, 4% real. You beat inflation by that and I don’t think anyone is going to be too angry with you.
Lindsay Williams: No, I don’t think so and I think, if a sophisticated international investor can have listened to that last description from you and can manage the currency risk via various instruments, then, goodness me, South Africa looks like a good place to be. What about international bonds though? The international bond market flying in the face of the South African situation, we are almost at odds with each other and that is one thing that, as a layman, worries me a little.
Malcolm Charles: Yes, that is our concern at the moment, that 2018 is a complete contrast to 2017. 2017 was a very supportive international market. You had reasonable growth across the board, very synchronised growth in Europe, Japan, America, etc. You had very accommodative monetary policy from those big markets, all helping emerging markets. Unfortunately, the local scenario in SA was dreadful. We had political risk, we had pillaging of our resources and a lot of uncertainty coming from the leadership of the country.
You move forward this year, it’s the exact opposite. Those same monetary authorities in the US are withdrawing liquidity, they are hiking rates, bond yields are ticking up, Europe is not growing nearly as well it was last year but, on the flipside, SA is probably the best we have been in 10 years – inflation is a surprise on the downside; we have had seven releases now where inflation has come out better than expected; you have got a very strong Reserve Bank; you have got a treasury that is rebuilding and you have got a President that is serious about leading this country and getting growth back on the table.
So that is the push-pull that we dealt with at the moment, is that you are very positive valuation and macros of South Africa but the foreign dynamics are making you cautious and I think you have to remain a little bit cautious with the volatility that we will get from Donald Trump and his mates.
Lindsay Williams: Okay. So we have got a foundation of optimism in South Africa which goes up a little bit here and down a little bit there but it is certainly on the up at the moment. You are worried a little bit about the international ramifications of the erratic nature of certain world leaders but how do you position yourself now, given all those things, and what are the opportunities?
Malcolm Charles: So positioning is we are very constructive of SA bonds so we are overweight bonds. What we have done is we have put a little bit of that into inflation linkers because that is a slightly risky way of putting these positions in the portfolio but to counter that is that we have got a couple of percent in FX, in dollars and euros, so if there is a bout of volatility, it just smooths the profile of the portfolio. So you can’t bet the farm at the moment but you can have an SA-centric, SA-positive portfolio and then you also use some optionality in the portfolio just to protect yourself should a crazy event happen.
So we are overall positive, we are overall overweight in the portfolio but you use a little bit of FX, a little bit of optionality as insurance should a crazy event happen in the near future.
Lindsay Williams: Malcolm, thanks very much for your time. That is Malcolm Charles, Portfolio Manager, Fixed Income at Investec Asset Management in Cape Town.
This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is not an invitation to make an investment and should not be construed as advice. The views in this podcast are those of the contributors at the time of publication and do not necessarily reflect those of Investec Asset Management. The value of investments can fall as well as rise and losses may be made. In South Africa, Investec Asset Management is an authorised financial services provider.