The Fund returned 0.75% in the first quarter of 2021 (Q1-21), bringing its total return to 9.1% for the 12-month period. This return is ahead of cash (4%) and its benchmark (4.4%).
In the US, the Federal Reserve Board (the Fed) left the funding rate range unchanged at 0.00%-0.25% and maintained the current asset purchasing programme pace and size. The Fed reiterated its stance that improvement in employment and inflation, and reaching its target ranges are necessary precursors of interest rate hikes. US headline inflation accelerated to 1.7% year on year (y/y) in February, from 1.4% y/y in January. Upward inflation pressure came from increases in energy costs and medical care service prices. Prices for food, vehicles and apparel were slightly lower than January's reading. Core inflation moderated slightly to 1.3% y/y in February from 1.4% y/y in January.
In emerging markets, China's headline inflation contracted by 0.2% y/y in February from a contraction of 0.3% y/y in January. This deflation is on the back of falling meat prices, along with a drop in transport, apparel and utility costs. Elsewhere in emerging markets, the roll-out of the vaccine in 2021 has been slow, but is expected to contribute to further recovery in economic activity in the latter part of the year. Monetary policy settings have become more mixed, with some emerging market central banks signalling broad accommodation, while Russia, Turkey and Brazil's central banks all raised interest rates in March.
The rand was relatively unchanged over Q1-21, despite broader emerging market currency weakness, ending at $1/R14.78. The onset of the second wave of Covid-19 in many parts of the world and increased developed market bond yields weighed on sentiment. However, underlying economic data continued to suggest better-than-previously-expected global growth outcomes. In South Africa, specifically, this has led to slightly improved expectations, supporting the currency outperformance over February. The Fund maintains its healthy exposure to offshore assets. When valuations are stretched, it will hedge/unhedge portions of its exposure back into rands/dollars by selling/buying JSE-traded currency futures (US dollars, UK pounds and euros). These instruments are used to adjust the Fund's exposure synthetically, allowing it to maintain its core holdings in offshore assets.
South African headline inflation slowed to 2.9% y/y in February from 3.2% y/y in January. The decline came from a moderation in food prices and a decrease in medical insurance costs. Core inflation fell more sharply, from January's 3.3% y/y to 2.6% y/y in February. Inflation pressure in the economy remains benign, and both core and headline inflation are anticipated to remain close to the 4.5% mid-point of the inflation target range.
At the end of March, shorter-dated fixed-rate negotiable certificates of deposit (NCDs) traded at 5.83% (three-year) and 7.08% (five-year), much higher than the close at the end of the previous quarter. This was in large part driven by a repricing in global rate expectations, following the selloff in developed market bonds. Shorter-dated NCDs have been pulled lower due to significant interest rate cuts, a recovery in bond yields and a tightening of credit spreads. Short-dated fixed-rate NCDs continue to hold appeal due to the inherent protection offered by their yields and our expectations of a lower repo rate. In addition, NCDs have the added benefit of being liquid, thus aligning the Fund's liquidity with the needs of its investors. The Fund continues to hold decent exposure to these instruments (fewer floating than fixed), but we will remain cautious and selective when increasing exposure.
South Africa remains in a delicate balancing act. In the short term, inflation will remain under control and growth will pick up, supporting a cyclically better economic outcome. However, the fiscal accounts are problematic, given the high levels of debt. While the cyclically better economic outcomes have provided some breathing room, there needs to be an acceleration in growth-enhancing reforms, more emphasis on reviving private-sector confidence to encourage investment and no deviation from current expenditure plans. The recent move higher in developed market bond yields has sparked concerns of a replay of the 2013 taper tantrum. However, local bond valuations are much more generous now, with a much-reduced external funding requirement. We view South African government bonds as an attractive investment opportunity and would still advocate an overweight position relative to the benchmark for a bond fund. In addition, we would also allocate to four-year inflation-linked bonds and steer clear of corporate credit spreads at current levels.
The local listed property sector was up 6.4% over the quarter, bringing its 12-month return to 34.4%. Listed property has been the largest drag on the Fund's performance. The balance sheet concerns coming out of the crisis have subsided somewhat as companies have managed to introduce dividend payout ratios, withhold dividends in some cases and sell assets. Going forward, operational performance will remain in the spotlight as an indicator of the pace and depth of the sector's recovery. We believe that one must remain cautious, given the high levels of uncertainty around the strength and durability of the local recovery. However, certain counters are showing value, given their unique capital structures and earnings potential. These counters remain a core holding within the Fund.
The FTSE/JSE Preference Share Index was up 2.1% over the quarter, bringing its 12-month return to 30.1%. Preference shares offer a steady dividend yield linked to the prime rate, and depending on the risk profile of the issuer, currently yield between 8% and 10% (subject to a 20% Dividends Tax, depending on the investor entity). The change in capital structure requirements mandated by Basel III will discourage banks from issuing preference shares, which will limit availability. In addition, most of the bank-related preference shares trade at a discount, which enhances their attractiveness for holders from a total return perspective and increases the likelihood of bank buybacks. Despite attractive valuations, this asset class will continue to dissipate, given the lack of new issuance and because of its associated risks being classified as eligible loss-absorbing capital (only senior to equity). The Fund maintains select exposure to certain high-quality corporate preference shares, but will not actively look to increase its holdings.
We remain vigilant of the risks emanating from the dislocations between stretched valuations and the local economy's underlying fundamentals. However, we believe that the Fund's current positioning correctly reflects appropriate levels of caution. The Fund's gross-of-fees yield of 6.52% remains attractive relative to its duration risk. We continue to believe that this yield is an adequate proxy for expected Fund performance over the next 12 months.
As is evident, we remain cautious in our management of the Fund. We continue to invest only in assets and instruments that we believe have the correct risk and term premium to limit investor downside and enhance yield.+