If ever there was a time for fixed income portfolios then 2020 is it. After racing out of the starting blocks at a frenzied pace and speed, it seems likely that the year to come will be remembered for the sheer range of momentous events that loom on the horizon.
In such an environment, the fixed income benefits of diversification, capital preservation, income generation and higher returns could not look more comforting. But even these portfolios must navigate a challenging global environment.
The lie of the land
First and foremost, the markets will be keeping a keen eye for most of 2020 on political developments in the United States. The race for the presidency is in full swing between the impeached-but-acquitted incumbent Donald Trump and former US vice-president Joe Biden. Regardless of the outcome, history will doubtless be made when Americans go to the polls in November.
In China, the Coronavirus is causing havoc with trade. The high virulence of the COVID-19 virus, combined with uncertainty about the reporting accuracy of both the rate of infection and mortality (given China’s preference for saving face), is becoming a notable concern for global health officials. There is a justified apprehension that Africa remains particularly vulnerable to the impact of the virus, given the rate of trade between China and the continent alongside a marked lack of preparedness in most African regions to deal with an outbreak of this nature and extent.
In South Africa, there is an upswing in the dissatisfaction of the local electorate over the perceived lack of progress being made in correcting the consequences of state capture. This sentiment is growing at the same time that the ongoing fightback of a loose coalition opposing President Cyril Ramaphosa is making it remarkably difficult to make further gains. The absence of clear consequences for the offending parties is emboldening the opposition and demoralising those with hopes for a better future.
Eskom serves as a dark reminder of the failures of the ruling African National Congress, and even though many South Africans may not care for the complexities involved in the debt dynamics and historical contractual irregularities, they certainly understand the severity and impact of sometimes daily blackouts. Ramaphosa’s State of the Nation Address in February served up a mix of good news and platitudes, however, the devil will ultimately be in the details and the implementation of the vision.
Asset performance overview
In spite of the political and social challenges, for the two years to the end of 2019 South African investors have seen some solid asset class performances. Global equities and bonds both had returns significantly in excess of inflation, but both South African bonds and preference shares stole the show with similar return numbers at significantly lower levels of volatility – returning 36% and 20% respectively.
There have also been some glimmers of light. Local inflation continues to be low and the last print surprised on the down side. This allowed the South African Reserve Bank (SARB) to cut rates and it is widely expected that the SARB will make at least one more cut over the next 12 months. This means that, looking ahead, cash-plus portfolios are unlikely to give you the CPI+4% that they have for the past few years, but one can still expect returns in the 7.5% to 8% range for 2020.
Some of the other asset classes also seem to offer increasing relative value as their gap to the one-year negotiable certificate of deposit (NCD) yield continues to increase. Bonds offer yields that range from 8.8% to more than 10%, depending on where you are positioned on the curve. Both our certificate of deposit spread, and our high real yield compared to peers seem to indicate that the Moody’s downgrade had mostly been priced in. Preference share yields have ticked up to almost 10%, which is especially attractive given the fall in the NCD rates – their current spread is at 2.67% compared to the decade average of less than 1.5%.
Watch the oddities and the opportunities
The outlier at the moment is property. With the recent fall in share prices coming on the heels of two years of poor performance, forward consensus yields have increased significantly. According to Bloomberg, the current forward consensus yield on Growthpoint is almost 11.3%. This is the highest it has been since 2009 and the highest compared to its peer asset classes over the same period. On a historical valuation basis, the company is looking extremely attractive.
The problem with the property sector remains that it currently has significant downside risks and lacks clear upside potential. Property is highly linked to the gross domestic product (GDP) growth rate of a country and the anemic growth anticipated for the South African economy continues to hamper the sector. When you combine that with the uncertainty surrounding the policy implementation of land expropriation without compensation, it is difficult to know what an appropriate yield level would be. Yet, regardless of the risks, as the yield continues to rise it is becoming increasingly difficult to ignore the sector.
Finally, amidst both global and local uncertainty, fixed income continues to be an attractive option for investors. As a result, those who would be happy with CPI+2%-4% for 2020 would do well to increase their allocation to these funds and wait out the risks on the horizon.
Albert Botha is the Head of Fixed Income Portfolio Management at Ashburton Investments