In the first quarter of 2021, the Amplify SCI Strategic Income fund returned 1.3%. This was above the category average for funds in the ASISA multi-asset income category, but is a reflection of how income funds are unlikely to repeat the returns of the past few years in the current interest rate environment.
Between 2016 and 2020, the fund delivered annual growth of 8.8%, 9.0%, 8.7%, 8.8% and 8.4%. That made it one of the top 10 performers in its category over this time.
Manager Erik Nel, the CIO at Terebinth Capital, said during a webinar last week that managing money in this environment requires being aware of an ‘ever evolving’ macro picture.
“We are approaching it from a “what if” scenario,” Citywire A-rated Nel said.
Bulls and bears
Much of this is focused on the enormous amount of stimulus in the global economy. There is significant debate about where this will lead.
“The bull argument is based around the premise that central banks and fiscal authorities will continue to stimulate the global economy,” said Nel. “In doing so, they will look through what they believe to be transitory inflation effects.”
This means that they will continue to run economies “hot” and do “whatever it takes” to support the recovery.
The bear case, in Nel’s view, is a scenario in which inflation is not transitory and continued stimulus leads to an over-heating in global economies.
“The risk is that central banks are going to under-appreciate that inflation will start feeding on itself,” said Nel. “They will fall behind the curve because they wait for second round effects before they react. By that stage it’s too late, because the tertiary effects would have already worked themselves into the economy.”
As an emerging economy, South Africa would be heavily impacted either way. The country is also facing its own reckoning.
In a bull case, the policy prudence that has been displayed by the Reserve Bank and National Treasury rubs off on the rest of the public sector. Wage negotiations are settled in the government’s favour, and reform in areas like energy supply and scarce skills visas take hold.
This would be supported by a global recovery which supports demand for commodities, boosting the profits of local miners. This acts as an underpin to improved local revenue collection.
“If we get those things right, we would start finding ourselves in a positive feedback loop,” Nel said. ‘Sentiment will improve, fixed investment will rise, the private sector will start supporting the economy. That would attract foreigners to our markets, which lowers the cost of funding, removes the excessive risk premium and becomes a self-reinforcing positive mechanism.”
In a bear case, however, South Africa would suffer under a faltering global recovery.
“That would be very negative for emerging markets,” said Nel. “It could lead to government abandoning its fiscal consolidation plans and using any tax windfall from mines to not lower the wage ball.
“In that scenario, a debt crisis ensues, and you reach a sudden stop scenario where you see a complete vacuum as foreigners exit. Authorities could panic and introduce things like prescribed assets, stop the outflows of money, and the Reserve Bank would take the hit through the currency channel. That would be highly rand negative, and whatever is bad for the rand is bad for inflation and by derivation interest rates.”
Without putting probabilities on either of these scenarios, Nel noted that investors have to consider that both are possible. There are also elements of both in Terebinth’s base case.
“Globally, that is an ongoing shift back words trend over time, where inflation recovers slightly due to stimulus. Locally, policies remain slightly suboptimal. There are tailwinds because of what is happening globally, but because of excessive debt levels, the economy remains contained. If the economy recovers slightly, you might even have a situation where The Reserve Bank removes some relief and raises rates.”
What is important for Nel is not building a portfolio that will only deliver if one of these three cases plays out.
“You do not position for a single outcome at the turn of a cycle,” he said.
Confidence is still wavering between whether the recovery will be sustained, whether the stimulus will work as intended, or whether it might be taken away too soon. There are also likely to be some markets that outperform and others that lag.
In the Amplify SCI Strategic Income fund, the manager is therefore taking a ‘barbell approach’.
Amplify SCI Strategic Income fund positioning
Source: Terebinth Capital, Amplify
Just over half of the fund is in cash, and quality cash-like instruments. About a quarter of the portfolio is held in nominal government bonds, and Terebinth has also aggressively built up a position in inflation-linked bonds after being short these assets for the whole of 2019.
The fund has only 4.5% exposure to tier 1 credit, and around 6% offshore as a hedge.
“Because we are not just positioning for a single outcome at the turn of a cycle, that is quite evenly spread across the dollar, US Treasuries and the Mexican peso. We also have a small exposure to the euro,” said Nel.
Patrick Cairns is South Africa Editor at Citywire, which provides insight and information for professional investors globally.
This article was first published on Citywire South Africa here, and republished with permission.