Tactical ideas for fixed income in an election year

By James Turp, Fixed Income Portfolio Manager at Sanlam Investments

Income funds at the shorter end of the yield curve provide a cushion against surprises in an environment of pre-election uncertainty and weak economic growth.

2023 turned out to be a good year for most fixed income investors, although it was not all smooth sailing. There were various risk events, such as #LadyRussiagate, the docking of the sanctioned Russian cargo ship at Simon’s Town Naval Base in May, which led to concerns about South Africa’s support of the war in Ukraine. After a difficult three quarters, bonds experienced a strong fourth quarter, which boosted income fund returns to between 9.5% and 12%, depending on risk allocations.

The market tells us that 2023 is the end of the rate hiking cycle, and South Africa’s repo rate has been unchanged at 8.25% since May. From mid-year, interest rates are expected to trend lower. In our tactical investment strategy for 2024, we need to factor in South Africa’s national election on 29 May as well as that in the United States on 5 November.

South Africa’s National Budget Speech, which took place in February, had very little market impact. The use of foreign exchange reserve profits to create short-term funding relief was received with mixed feelings. Eyes now turn to the elections, which could cause market volatility, depending on the results.

Comments from the South African Reserve Bank (SARB) seem to indicate that rate cuts will not precede the election. The SARB’s initiative to create a lower inflation target also makes it seem unlikely it will move before it is confident of the inflation trajectory. This plan was recently backed by the National Treasury. By lowering the inflation target for monetary policy from its current band of between 3% and 6% to a possible point target of 3%, the SARB will entrench lower inflation expectations, which should result in longer-term sustainably lower policy rates.

South African bonds have not meaningfully outperformed cash for several years. Fiscal metrics have deteriorated as the government has needed to borrow more in an environment of weak economic growth, which has driven bond yields higher. Current bond yields for 10 years and longer are returning 11.5% to 12.5%. If inflation can stabilise and move lower, real returns from bonds will be hard to ignore. But for the time being our lower-risk portfolios have been delivering the best returns.

Financial markets are vulnerable to surprises and this makes it difficult to take long-term exposure to the yield curve unless it is managed within a portfolio. Until we see progress in creating balanced and sustainable economic growth, the market will be susceptible to risk events.

Given expectations of lower rates later this year, our cash plus and multi-asset income type funds offered by Sanlam Investment Management are looking promising. The Sanlam Investment Management Core Income fund (a unit trust in cash plus segment) aims to return yields above money market funds while creating an interest rate exposure similar to that of a one-year fixed deposit. This fund has consistently outperformed fixed deposits in all rate cycles. The Sanlam Investment Management (SIM) Core Income Fund has a current yield of 9.76%, which equates to a nominal effective return before fees of more than 10%. One-year deposit rates are a full percent lower. If interest rates are cut in the second half of this year, the floating rate portion of this fund will gradually reduce the yield by year-end. If rates increase due to unforeseen risks in the market, the yield will rise, as it holds a high portion of floating rate assets.

Also, the Sanlam Investment Management Tactical Income Fund (a unit trust in the multi-asset income segment) gives additional exposure to the bond yield curve. From an interest rate exposure perspective, the fund is the equivalent of a two-year deposit, but it has a nominal effective yield of about 10.5% before fees. If interest rates trend lower, this fund should provide attractive returns because of its longer interest rate exposure.

These two unit trusts invest in “Big Five” local bank assets and government bonds and offer cash-like liquidity for any unexpected cash calls, which is an attractive feature in an environment of uncertain economic growth. If South Africa’s economic outlook improves, the funds will benefit from lower interest rates along the steep interest rate yield curve.

Disclaimer

The Sanlam Group is a full member of the Association for Savings and Investment SA. Sanlam Collective Investments (RF) (Pty) Ltd is a registered and approved Manager in terms of the Collective Investment Schemes in Securities. Collective investment schemes are generally medium- to long term investments. Past performance is not necessarily a guide to future performance, and that the value of investments / units / unit trusts may go down as well as up. A schedule of fees and charges and maximum commissions is available from the Manager on request. The Manager does not provide any guarantee either with respect to the capital or the return of a portfolio. The funds may from time to time invest in foreign countries and therefore it may have risks regarding liquidity, the repatriation of funds, political and macroeconomic situations, foreign exchange, tax, settlement, and the availability of information. A feeder fund is a portfolio that, apart from assets in liquid form, invests solely in a single portfolio of a CIS, which may levy its own charges, and which could result in a higher fee structure for the feeder fund. Full details of the awards are available from the Managers. The Manager retains full legal responsibility for the co-brand portfolio.

Sanlam Investments consists of the following authorised Financial Services Providers: Sanlam Investment Management (Pty) Ltd (“SIM”), Sanlam Multi Manager International (Pty) Ltd (“SMMI”), Satrix Managers (RF) (Pty) Ltd, Graviton Wealth Management (Pty) Ltd (“GWM”), Graviton Financial Partners (Pty) Ltd (“GFP”), Satrix Investments (Pty) Ltd, Amplify Investment Partners (Pty) Ltd (“Amplify”), Sanlam Africa Real Estate Advisor Pty Ltd (“SAREA”), Simeka Wealth (Pty) Ltd and Absa Alternative Asset Management (Pty) Ltd (“AAM”); and has the following approved Management Companies under the Collective Investment Schemes Control Act: Sanlam Collective Investments (RF) (Pty) Ltd (“SCI”), Satrix Managers (RF) (Pty) Ltd (“Satrix”) and Absa Fund Managers (RF) (Pty) Ltd. Sanlam is a full member of ASISA. Please note that past performances are not necessarily an accurate determination of future performances, and that the value of investments/collective investment units/unit trusts may go down as well as up.

The information in this article does not constitute financial advice. While every effort has been made to ensure the reasonableness and accuracy of the information contained in this document (“the information”), the FSP, their shareholders, subsidiaries, clients, agents, officers and employees do not make any representations or warranties regarding the accuracy or suitability of the information and shall not be held responsible and disclaims all liability for any loss, liability and damage whatsoever suffered as a result of or which may be attributable, directly or indirectly, to any use of or reliance upon the information.