THE CORONATION STRATEGIC Income Fund, our managed income fund aimed at investors with a time horizon between one and three years, recovered strongly after the market dislocation in March, returning 4.8% during the second quarter of 2020 (Q2-20). Over one year, the fund returned 4.5%, which is 1.9% behind cash (measured using the STeFI 3-month Index) and over three years, it returned 7.1% per annum, which is 0.3% p.a. ahead of cash.
Domestic income assets continued their roller-coaster ride during Q2-20, with bond prices recovering strongly after the unprecedented sell-off in the first quarter of the year. Shorter-dated bonds performed better than longer-dated bonds due to concerns about the deterioration in government finances. The current yield on the 10-year South African government bond (SAGB) is still high at 9.5%, which represents an elevated risk premium over cash, inflation and bonds issued by other governments around the world.
This reflects the reality that South Africa is on the brink of a debt trap, and although promises have been made to restore the country to a more sustainable debt trajectory, implementation risks remain elevated. However, the valuation of SAGBs does provide some offset to this, implying that local bonds do warrant at least a neutral allocation.
STATE OF PLAY
We expect inflation to remain modest over the next three years, with a forecast annual inflation rate of 3.5% p.a. The South African Reserve Bank has room to reduce rates by a further 50 basis points and is likely to keep rates low over the next 12 to 18 months to support the economic recovery. Our base-case assumptions imply a cash return of 3.35% over the next 12 months.
The rand was stronger, ending June at $1/R17.05. The easing of lockdown measures globally served to buoy risk sentiment and supported emerging market currencies. However, the local fundamental backdrop remains poor. The Fund therefore 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 dollar, UK pound and euro). These instruments are used to adjust the Fund’s exposure synthetically, allowing it to maintain its core holdings in offshore assets.
The local listed-property sector was up 18.7% in Q2-20 but is still down 40% over the rolling 12-month period. Despite starting the period with a small allocation, listed property was the largest drag on performance over the past year. We remain cautious about this asset class. The crisis will reduce rental income, put pressure on asset values, increase the cost of borrowing for lower-quality businesses and test inexperienced management teams. This increases balance-sheet risk across the sector. It is entirely possible that many of the companies will require additional capital and that dividends will be suspended to preserve capital. The Fund is invested only in select large-cap counters that satisfy our stringent conditionality.
We believe that the Fund’s current conservative positioning correctly reflects appropriate levels of caution. 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. The Fund’s current yield of around 6% 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. +
For a comprehensive review of the local and global bond markets, refer to the Bond Outlook, On the Brink.
Coronation Strategic Income: Highest annual return 18.7% Nov 2002 - Oct 2003; Lowest annual return 2.0% Apr 2019 - Mar 2020