What is the outlook for fixed-income portfolios?
Benefits of diversification, capital preservation, income generation and higher returns are comforting
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, it seems likely that the next year 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 markets will be keeping a keen eye for most of 2020 on political developments in the US. 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 doubtlessly be made when Americans go to the polls in November.
In China, the coronavirus is causing havoc with trade. The high virulence of Covid-19, combined with uncertainty about the reporting accuracy of the rate of infection and mortality, is becoming a notable concern for global health officials. There is 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 SA, there is an upswing in dissatisfaction among the electorate over the perceived lack of progress in correcting the consequences of state capture. This sentiment is growing while the ongoing fightback of a loose coalition opposing President Cyril Ramaphosa is making it 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 stark reminder of the ANC’s failures, and even though many South Africans may not care about 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, but the devil will be in the details and the implementation of the vision.
Despite the political and social challenges, for the two years to the end of 2019 SA investors experienced some solid asset class performances. Global equities and bonds had returns significantly above inflation, but SA 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 hope. Local inflation continues to be low and the last print surprised on the downside. This allowed the Reserve Bank to cut rates, and it is widely expected that the Bank will make at least one more cut over the next 12 months. Cash-plus portfolios are thus unlikely to deliver the CPI+4% in future that they have for the past few years, but one can still expect returns in the 7.5%-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 with peers seem to indicate that the downgrade by Moody’s Investors Service had mostly been priced in.
Preference share yields have ticked up to almost 10%, which is especially attractive given the fall in NCD rates — their current spread is at 2.67% compared with the decade average of less than 1.5%.
The outlier is property. With the recent fall in share prices after 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 with 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 now has significant downside risks and lacks clear upside potential. Property is highly linked to a country’s GDP growth rate, and the anaemic growth anticipated for the SA economy continues to hamper the sector. Combined with the uncertainty about 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.
Amid global and local uncertainty, fixed income continues to be an attractive option for investors. Those who would be happy with CPI+2%-4% for 2020 would thus do well to increase their allocation to these funds and wait out the risks on the horizon.
• Botha is head of fixed income portfolio management at Ashburton Investments.
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