SA bonds offer enticing returns for 2023

President of the European Central Bank (ECB) Christine Lagarde has warned that the bank is not done raising interest rates and that inflation still has a way to go. Her statement follows rising optimism about easing eurozone inflation, driven by a sharp fall in European wholesale energy prices, combined with an easing of supply chain bottlenecks. 

With this environment in mind, SA’s leading balanced and multi-asset fund managers are going off script in search of market-beating returns for investors through 2023, as they find it increasingly difficult to call patterns based on historic market performances — considering the almost unprecedented market conditions they face. 

“Many commentators compare today’s low-growth, high-inflation and high oil-price environment to the 1970s and suggest fund managers can use these similarities as a magical, historical road map to predict market inflection points,” says Jason Swartz, portfolio manager at Old Mutual Investment Group’s (OMIG) MacroSolutions capability. Unfortunately, there is no rule or historic pattern that accurately predicts market peaks and troughs.

He says the best fund managers can do is continually assess their asset allocation themes and valuations in light of prevailing macroeconomic conditions. And based on these assessments, they can ensure their portfolios contain the correct mix of bonds, cash, equities and listed properties in domestic and offshore markets. 

“We rely heavily on macroeconomic inputs to perform our asset allocation function,” says Swartz, before singling out global inflation and rapid liquidity tightening (rising interest rates) as major influencers of fund manager decision making. It turns out there was nowhere for investors to hide in 2022, with inflation and interest rate shocks causing the bond and equity asset classes to fall simultaneously.

The 10% improvement in US share prices during October 2022 has tempted many portfolio managers to increase their exposures to offshore equities, but Swartz and his team believe such buying action will prove premature. He adds that in terms of offshore exposure, it makes more sense to increase exposure to global bonds in current market conditions. With US 10-year yields just below 4%, global bonds offer a reasonably attractive entry point relative to its own history, and global equities. Additionally, this asset class should benefit from tailwinds created from global inflation peaking and increased risks to a global recession in 2023.

The role of the rand

“Whether a multi-asset fund outperforms or underperforms its competitors largely hinges on its currency exposure, and effectively the ratio of its global to local assets,” says Swartz. And that means a credible view and risk management strategy on the rand vs US dollar is non-negotiable when building multi-asset portfolios.

Swartz says the rand is oversold at levels of about R17,20 to the dollar, and predicts that improvements in SA’s fiscal accounts and terms of trade could provide tailwinds for the currency over the coming months.

“The rand has a disproportionate impact on multi-asset portfolios, and that’s something we are paying a lot of attention to,” says Swartz. At stronger levels of the rand to the dollar, he says, they would be looking to move assets offshore, because on a long-term basis they remain concerned about the country’s performance on reform, particularly in energy, infrastructure and regulation, as well as fading tailwinds from strong fiscal performance from high commodity prices. 

Low economic growth (forecast at less than 2% for 2023) and weak business confidence are also predicted to weigh on the rand’s long-term prospects. 

Armed with this currency view, portfolio managers can focus on the best return opportunities from domestic asset classes going into 2023. According to Swartz, SA equity has been cheap for some time and offers compelling value against equities in both developed markets and other emerging markets. 

“Locally listed stocks have a much better chance of delivering positive earnings growth in the coming year than global counterparts, and these have proven quite resilient in a tough economic environment. 

“Decent earnings from many of these firms will support a compelling price-earnings valuation of eight or nine times forward on the JSE.”

The argument for SA bonds is even more compelling after a disappointing performance from the asset class through 2022. 

“There has been a lot of sovereign risk priced into our bonds and we expect some of that risk to unwind in 2023 and the fact that we are close to the peak in interest rates and inflation should support a re-rating in the domestic bond market.” 

He says the 11% yield on SA government bonds exceeds the 6% on offer from cash or 7% from money market instruments. If bond yields turn during the year, then it is likely SA bonds could deliver a 15%-20% return for multi-asset portfolios in 2023.

“On a risk-adjusted basis, we have tilted our balanced and multi-asset portfolios towards SA bonds. We have actively bought bonds into weakness and are quite optimistic with the resulting asset allocation.

“Historically, cyclical sectors tend to outperform during periods of falling global inflation and increasing equity exposures to such sectors, while managing exposure to a global slowdown will be a defining ‘play’ for 2023.” 

This article was paid for by Old Mutual Investment Group.