Nishan Maharaj is Head of Fixed Interest and has 20 years of investment experience.

Mauro Longano is Head of Fixed Interest Research and a portfolio manager with 11 years of investment industry experience.

The Fund returned 2.4 % in the fourth quarter of 2020 (Q4-20), bringing its total return to 4.5% for the 12-month period. This return is behind cash at 4.8%, and the Fund’s benchmark at 5.4%. During periods of extreme uncertainty that result in poor asset class performance, where many assets underperform cash, the best that managed income fund investors can hope for is a return in line with or slightly below cash.  In a multi-asset class portfolio, even if one could move the entire portfolio to cash at exactly the right point, the costs incurred in doing so would still result in a return that is below cash returns. This is how asset class behaviour played out in 2020. Inflation-linked bonds (ILBs) produced a return of 4.2%, preference shares returned -11.3% and listed property returned -35.5%. Only bonds, with a return of 8.7%, produced a return above cash. South African government bonds (SAGBS) continue to be our preferred asset class, but to produce a portfolio return that is line with historical experience (cash + 2%, which was c.6.8% in 2020), the required bond exposure level is too high to be consistent with the Fund’s risk budget.

The local bond market yield curve steepened aggressively, with the 10-year bond trading in excess of 200 basis points (bps) above the five-year bond and almost 600bps above cash rates. As a result, the three- to seven-year area of the yield curve provided the best return in 2020, at 16.3%, and the longer end of the curve (>12 years) provided the poorest return of 4.6%. ILBs delivered poorer absolute returns of 4.2%, but provided a similar pattern of return across the ILB yield curve (the front end outperforming the longer end).


In the US, the Federal Open Market Committee left the target range for the federal funds rate unchanged at
0%-0.25% at its December meeting. The Committee's guidance indicated that it would closely monitor the pace and size of asset purchases until substantial economic progress has been made towards meeting its inflation and employment targets. The US Congress passed an $892 billion Covid-19 stimulus package to shield the economy from the effects of the pandemic. Headline inflation in November was unchanged from October's print of 1.2% year on year (y/y). Medical care services prices continued to decline, together with transport costs. Core inflation remained unchanged at 1.6% y/y.

In emerging markets, China’s headline inflation contracted by 0.5% y/y in November, following an increase of 0.5% y/y in October. This moderation came on the back of a sharp decline in food prices and a slowdown in transport, household goods and services prices. Core inflation remained unchanged at 0.5% y/y. Elsewhere, the impact of Covid-19 on growth is still evolving, with many countries still battling rising infection rates and relatively stringent lockdown restrictions. Central banks, on balance, are maintaining their accommodative stance.


The South African economy grew by 66.1% on a seasonally adjusted average (saa) quarter-on-quarter (q/q) basis for the third quarter of 2020 (Q3-20). This follows a revised 51.7% saa q/q contraction in Q2-20. The sectors with the most robust production-side recoveries were mining, manufacturing and trade. From the expenditure side, household consumption and net exports were the biggest drivers of growth. Early data surveys for performance in the fourth quarter show normalisation of production in most sectors, supported by strong global demand and stable commodity prices. However, the recent spike in Covid-19 infections and renewed lockdown restrictions pose a considerable downside risk to growth going forward, notably in the absence of an effective vaccination strategy. This may create an opportunity for further rate cuts.

The rand gained 14% against the US dollar over Q4-20, ending the year at $1/R14.69. The easing of lockdown measures globally and initial indications that the expected contraction would not be as severe as initially thought, served to buoy risk sentiment and emerging market currencies. However, the local fundamental backdrop remains quite poor. The Fund maintains its healthy exposure to offshore assets and, when valuations are stretched, 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. In addition, the Fund currently has option structures in place to protect its holding if the rand moves materially below $1/R16 on a sustained basis.

At the end of December, shorter-dated fixed-rate negotiable certificates of deposit (NCDs) traded at 4.8% (three-year) and 5.8% (five-year), tighter than the previous month. Shorter-dated NCDs have pulled lower due to the significant interest rate cuts, recovery in bond yields and tightening of credit spreads. Short-dated fixed-rate NCDs continue to hold appeal due to the inherent protection offered by their yields and relative to our expectations for a lower repo rate. In addition, NCDs have the added benefit of being liquid, thus aligning the liquidity of the Fund 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


The globe and South Africa remain firmly in the grips of the second wave of infections. As the numbers turn into names and the names turn into people we know, the harsh reality of Covid-19 has dawned on many of us as we enter 2021. Even more stark are the difficult tasks and choices that lie ahead of the country.  South Africa remains on the precipice of a debt trap. 

There are only two ways to escape: either increase growth so that tax revenue rises sufficiently to compensate for increased spending, or decrease spending to balance the equation. This needs to be done while keeping borrowing costs low enough to ensure that debt financing doesn’t consume all available expenditure and that no extraordinary support is needed by any State-owned or guaranteed entity. Inflation is expected to remain relatively well contained over the next two to three years, averaging around 4.5% over the period.  This means that one needs to see real growth of 3%-4% to generate nominal growth of c.8%, which is needed to stabilise the nation’s debt profile. 

Government has made progress towards reigniting local growth by attempting to revive business confidence and infrastructure development. However, this will only bear fruit over the medium to longer term. This means that expenditure will have to be reallocated and contained until growth starts to pick up. Progress is being made in this regard with the high court ruling in favour of the 2020 public sector wage freeze and government attempting to keep wages frozen for the next three years. The health of State-owned companies and municipalities remains a concern, with Covid-19 placing even further pressure on these vulnerable entities.  Thus, the risk of fiscal slippage is high, rendering the fundamental economic backdrop unsettled.

Underlying economic conditions are easing, but remain challenging, given South Africa’s poor starting point.  Inflation will remain under control, but a stronger shift needs to be made towards higher growth without pushing the country further into a debt trap. Progress has been made by reallocating expenditure away from a bloated wage bill towards pro-growth elements; however, further unpalatable austerity might be required if reforms are not accelerated. SAGBs, despite their rally at the end of 2020, still encapsulate a significant risk premium that provides a decent offset to the underlying fundamental backdrop. Shorter-dated ILBs, with their elevated real yields and inherent inflation protection, also provide an attractive allocation opportunity for income portfolios.


The local listed property sector was up 23.6% in the last quarter of 2020, reducing its decline to -35.5% over 2020. Listed property has been the largest drag on the Fund’s performance. The current crisis will reduce rental income, put pressure on asset values, increase the cost of borrowing for lower-quality businesses and test inexperienced management teams. It is entirely possible that most of the companies will require additional capital and that dividends are suspended to preserve capital. One must be cautious not to take high yields at face value and understand how the key issues mentioned above affect that yield. We believe there are a few select large-cap counters that satisfy our stringent conditionality. 

The FTSE/JSE Preference Share Index was up 13.9% in the last quarter, bringing its 2020 return to -11.3%. 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. This 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 underlying fundamentals of the local economy. However, we believe that the Fund’s current positioning correctly reflects appropriate levels of caution. The Fund’s yield of 5.36.% 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.

Nishan Maharaj is Head of Fixed Interest and has 20 years of investment experience.

Mauro Longano is Head of Fixed Interest Research and a portfolio manager with 11 years of investment industry experience.