A fixed income masterclass – inflation, interest rate and yield insights

Investors considering fixed income funds need to be mindful of a range of factors, from macroeconomic trends to their risk tolerances, writes James Turp, Head of Fixed Income Investment Strategy at Sanlam Investments Active Manager.   

In fixed income investing, capital preservation and risk tolerance are closely interlinked. Capital preservation is an investment strategy aimed at protecting capital and avoiding value loss; something that is best achieved in shorter-term interest rate products. For investors seeking capital appreciation, fixed income funds with more exposure to higher-risk asset classes – such as government bonds, property or inflation linked bonds – may be appropriate. These funds are suited for risk-tolerant investors with a longer-term outlook.

Inflation is a crucial consideration in fixed income investing. Defined as a decrease in the purchasing power of money, inflation poses a significant challenge to fixed income investments. Competent fixed income managers strive to generate a return that exceeds current inflation, known as real returns.

Three key factors will influence the choice of a fixed income fund:

1. Liquidity and the frequency of interest or dividend distribution;
2. volatility, which affects the timing of your entry or exit from the fund; and
3. the time value of money, which suggests that the longer duration assets within a portfolio have a higher opportunity cost and consequently, should pay a higher return, whilst also having more volatility.

Sanlam Investments Active Manager’s offerings in fixed income

These fixed income fundamentals apply to Sanlam Investments Active Manager’s Fixed Income funds. As active fixed income managers, we strive to deliver consistent excess risk-adjusted returns, to help us deliver inflation beating returns.

Our lowest-risk fixed income products are money market funds, with the advisable investment period of overnight to three months, e.g., the SIM* Money Market Fund. The next step up along the risk curve are the so-called cash plus funds, the R20 billion SIM* Core Income Fund fits in this space.

This fund may hold longer-term interest yielding assets and the fund’s interest rate risk is capped at 12 months. It is recommended for investors with an indicative three- to 12-month investment horizon.

One step further up is the SIM* Enhanced Yield Fund, an income fund that is also in the short-term category but may take interest rate risk out to two years and has a more diverse exposure to credit.

The fastest-growing segment of South African fixed income funds is multi-asset income. These funds may hold a combination of bonds, inflation-linked bonds, some property and small amounts of equity exposures – even offshore assets, subject to prudential limits. Sanlam Investments Active Manager has two funds in this space: the domestic only R4.1 billion SIM* SA Active Income Fund, which targets STEFI plus 1%; and the R3.7 billion SIM* Tactical Income Fund, which aims for 2.5% above the three-month deposit rate and may use its offshore limits tactically.

The riskiest fixed income funds are bond funds, which should be held for at least 18 months due to their volatile return. Sanlam Investments Active Manager has two funds in this category: with the largest being the SIM* Bond Fund, which is benchmark-unconstrained and suitable for long-term investors.

Conclusion

In the US, post-pandemic inflation shows signs of cooling. Analysts expect a total of at least 100-basis points of cuts in the Federal Reserve rate this year.

South Africa’s inflation rate did not rise as high as in the US and UK, nor has it fallen as much. It is expected to move to around 4.5% on average in 2025. South African consumers could benefit from more than 1% in cuts between now and the end of next year.

Midway through 2024, the real yield – the difference between the yield on a 10-year government bond and inflation – was over 3%. This real yield remains attractive by global standards, even if the domestic inflation outlook triggers a 50-100 basis point interest rate cut.

These are all important considerations for portfolio managers, and we believe conditions might be favourable for an upweighting of duration through the second half of 2024.

View factsheets here.

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. Sanlam Investment Management (Pty) Ltd is an authorised financial services provider in terms of the Financial Advisory and Intermediary services Act.

The full registered name of the portfolios are Sanlam Investment Management Money Market Fund, Sanlam Investment Management Core Income Fund, Sanlam Investment Management Enhanced Yield Fund, Sanlam Investment Management SA Active Income Fund, Sanlam Investment Management Tactical Income fund and Sanlam Investment Management Bond Fund.