MICHAEL DE LA HUNT: Emerging market bond funds may be shock absorber we have been looking for

Recent months have seen a large degree of market turbulence, with sell-offs in financial markets throughout the world. This has been a particularly harrowing time for investors in SA, who have been sucker-punched by the added, compounding effects of domestic market conditions and economic constraints.

Load-shedding, coupled with policy uncertainty across a range of sectors and rising input costs for many businesses, have left even the most seasoned of investors feeling up a creek without a paddle. With the S&P 500 headed for a grim quarterly milestone (last seen in early 2009), down 3.6% and heading for its third straight decline, one would be forgiven for feeling anxious to say the least.

Thankfully, SA continues to have a thriving primary and secondary government debt market, despite our country’s sluggish long-term growth forecast, infrastructure challenges and growing public debt. This has been underpinned by our country’s well-functioning fiscal and monetary policy system, which supports consistent and stable yields in its long-term bonds.

For those who may be unaware, SA’s bond market plays an integral role in supporting the stability and development of our country’s financial market. And it has an impressive track record worth noting, reaching yields as high as 12% in the past two years while outperforming those of other emerging bond markets (including those of China, Indonesia, Brazil, India and Mexico).

Some would be pleasantly surprised that our bond market became a global pacesetter in 2021, with a total return of 8.7% in 2021. In this sense, SA’s bond market was able to compete against and outperform those of some of the world’s most developed economies, including Japan.

If that does not make you think twice about their capacity to preserve and generate wealth in an uncertain global economic environment, consider a comparison to its equivalent counterpart in the US. At present, the US 10-year Treasury bond’s real yield is -4.816%. The real yield represents the annual yield of the bond (3.447%) less the current US consumer price index inflation rate (8.263%).

These figures indicate that investors are actually losing 4.816% on this investment after adjusting for inflation. On the other hand, the SA 10-year government bond’s real yield is 2.535% (the annual yield is 10.335% and the CPI inflation rate 7.8%), indicating that the SA 10-year government bond yield, on a real basis, is 7.351 percentage points above that of the US Treasury.

This comparison helps illustrate that at present the overall market risk outlook remains neutral, with rising interest rates causing bond yields to increase expectantly above consensus. As policy and the global economic environment continues to change, an active and research driven investment management approach to emerging market bond funds will be essential if investors want to manage volatility while engaging in attractive opportunities that may aid in further developing SA’s financial market in a globally competitive arena.

That said, there is still a wide variety of inefficiencies in the bond market as a result of a traditional investor base, instilled human biases and a lack of widespread adoption of alternative data and data science. The unprecedented growth of passive bond exchange traded funds has created dislocations that will move the pricing of bonds away from fundamentals. This will in effect produce many opportunities for active investment strategies, which investors should position themselves to capitalise on.

Investing in an SA bond fund will afford investors the added protective layer of genuine SA innovation following the localised launch of the first of its kind, actively managed, high yield quantitative bond fund in Cape Town, which aims to provide downside protection and stable yields to investors in SA and across the globe. 

The Strelka Quant Bond Fund (launched towards the end of September) has positioned SA to investors as an emerging market economy with the most attractive (comparative) risk profile for bond market investments worldwide and seeks to invest in a number of high yield emerging market bonds through the use of innovative quantitative investment strategies that are back-tested against the latest, up-to-date empirical bond data to capitalise on index inefficiencies, and any institutional regulatory shortcomings where relevant. This helps hedge investments against bond price movements, interest rate sensitivity and overall market volatility. 

Local and international investors should be encouraged to commit their savings to emerging market bond funds as a versatile asset class that has been proven to be far less volatile than any other equity class in the current economic climate.

Investing in resilient and innovative SA bond funds may be the shock absorber investors have been seeking to ensure the continued preservation and generation of their wealth, especially at a time of such heightened economic uncertainty worldwide.

• De la Hunt is cofounder and fund manager at Ion Capital Partners.