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Just how attractive are SA government bonds?

The biggest concern is the duration of the investment – Paul Marais of NFB.
On a 10-year bond, an increase in interest rates of 2% during the life of the bond eliminates 1.5 years of yield. Image: Shutterstock

In the current environment, South African nominal government bonds appear to be an attractive investment. But are they really as attractive as they appear?

There is no question that taken purely from an income point of view, bonds appear attractive given that the yield curve is steep with cash rates significantly lower than long bond rates.

The yield on a 10-year bond is approximately 9.5% and the same value for three-month debt is 3.53%, resulting in a difference, or spread, of 5.72%. A year ago this spread was 2.37%. In other words, investors can now earn more than twice the spread for the same increase in time to maturity, making for a significantly more attractive investment case.

Rate cuts

The change in spread can be attributed to both three-month rates going down after the South African Reserve Bank (Sarb) cut interest rates dramatically to support Covid-19 relief efforts and an increase in 10-year rates as the government’s fiscal position has become increasingly precarious.

Bonds also offer an attractive return relative to inflation: 9.5% on a 10-year bond versus inflation, which is currently under 3%.

However, while the investment case for bonds appears to be strong given that the yield curve is as steep as it has ever been, in reality this is not a risk-free investment. The biggest concern around South African government bonds is the duration of the investment.

The key point to bear in mind is that the spread is only earned if the investment is held to maturity. In the case of a 10-year bond, this is 10 years away.

A holding period any shorter than that exposes the investor to capital risk.

The modified duration for a 10-year South African government bond is currently 6.5. A 1% increase in interest rates results in a 6.5% fall in capital values. Between the end of May 2020 and the first week of July 2020 – a six-week period subsequent to the lockdown induced sell-off where yields rose 5% – the yield on the 10-year bond rose from 8.8% to 9.5%, wiping out half of investor’s interest income for the year. On a 10-year bond, an increase in interest rates of 2% during the life of the bond eliminates 1.5 years of yield.

Even though interest rates are likely to go lower, making long-bond yields even more attractive, they are not likely to go significantly lower and are unlikely to stay at these levels throughout the life of the bond.

In other words, their attractiveness to cash will degrade over time.

The same can be said for their attractiveness relative to inflation, which is also currently at the bottom of the cycle. Those investors who don’t have a 10-year investment horizon are under appreciating this risk.

Investors will also need to reconcile the investment case for bonds with what is often a very bearish view on South Africa. This emotional gap will need filling throughout the life of the bond, as evidenced by the recent capital losses experienced in the bond market. Given South Africa’s implementation track record, a lot can go wrong within a 10-year investment horizon.

The prescribed assets factor

Also worth noting is that prescribed assets are likely going to be in some form of ownership of government bonds, most likely infrastructure bonds but this is very likely to include existing ownership of regular nominal and/or inflation-linked bonds.

A bond purchase now may allow investors to get ahead of prescribed assets legislation at a yield of their choosing.

If prescribed assets are enacted, investors’ choice of when to invest and thereby the luxury of assessing whether yields are sufficiently compensatory, goes away.

Also, keep in mind that prescribed assets effectively introduces an artificial buyer into the market which must distort the yield; most likely by capping how far it can rise. This is both a good thing in that bond investors to which prescribed assets do not apply have someone to offload to, but that is far outweighed by artificial demand dragging yields down and thereby putting a cap on how well investors can be rewarded for the risk they’re taking,

Paul Marais is managing director of NFB Asset Management, part of AltX-listed NVest Financial Holdings

COMMENTS   17

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I just cannot justify in my own mind 10 years with the SA government. Surely investing in a 10 year Government bond is like playing Russian Roulette. Unless there is an extraordinary change or events we will be lucky to even have a democracy in 10 years let alone an economy. Our government is oblivious of the rules and regulations of virtually everything.

As a complete novice regarding gov bonds my first thoughts are you must be stupid trusting the current lot to have any money in 10 years ?

I am lost : does the article assume one buys the government bond at issue date at face value and hold for duration? I’d imagine a bond with R100 face value and 10% interest rate issued in 2018 would now be trading at more than R100?

yes it would if there is sufficient liquidity.

The face value is what you get back at the end, if you hold the bond to maturity. The issue price will depend on the coupon rate (the interest rate paid relative to the face value of the bond) and the market’s yield requirement at the time. So a 2018 10-yr bond with R100 face value paying a 10% coupon (if that happened) would not have been issued at R100, but at a higher price.

But a 10-year bond is usually not a bond that has just been issued with a 10-year duration, but a longer-dated bond that is now 10 years from maturity.

As someone approaching retirement age and without the option of emigrating due to age and insufficient capital to buy foreign residency, either through a business or a property, putting some money into a government bond to provide a regular monthly income sounds like it may be a good option. However, it is a speculative investment, given the sovereign credit rating, so not wise to put too many eggs in this basket case. Given the ANC’s policy direction it seems likely that a million odd invested may only not be sufficient to buy a loaf of bread in 10 years time but I am stuck here and need something to live on in the interim.

As someone approaching retirement age and without the option of emigrating due to age and insufficient capital to buy foreign residency, either through a business or a property, putting some money into a government bond to provide a regular monthly income sounds like it may be a good option. However, it is a speculative investment, given the sovereign credit rating, so not wise to put too many eggs in this basket case. Given the ANC’s policy direction it seems likely that a million odd invested may only not be sufficient to buy a loaf of bread in 10 years time but I am stuck here and need something to live on in the interim.

Valuable article, thanks Paul Marais! One becomes so accustomed to comparing interest rates on money market & fixed deposits, that one forgets bonds have extra layers of complexity. Oh, the joy when you hear bond rates have increased, only to be followed by the disappointment when you see what has happened to the capital value!

Something has got to give, either SA goes to the IMF and SA Gov Bonds drop in price or things turn around.
I say SA is currently in the middle of it and could go either way, with all the money printing globally, a 50/50 portfolio of Global Equities and SA Gov Bonds may be the trade of the decade for a South African.

You could look at 5 year RSA Retail Bonds for individuals?

It all depends. What is the reason you are buying the bonds? If it is purely for income and you already have a large SA exposure why not buy bonds from other emerging markets.

I’d think of it like this, why are you buying SA bonds instead of Argentinean, Rwandan, Thai or Latvian bonds? Is it just because it’s a home bias, or because it’s the best risk-reward of the bunch. If you don’t know the answer, rather buy a global/emerging market bond fund.

The writer of the article does not say what are the chances of you getting your money out of the government in 10 years’ time. Also, will there be a democratic government or will we be a communist state? All indications and history tells us that the chances that we will not be a failed state like Zimbabwe are virtually NIL. SA is following the same path as Zimbabwe. First large scale corruption, looting and nepotism, and then landgrabs. Read the news.

Yup. Another indicator is SA’s continual moving down the scale of various global rankings (be it education, science & tech, GDP per capita income, debt as % of GDP, crime stats, value of passport rankings, Corruption Index, Competitiveness ranking, Unemployment rate….and then what you can see with “Mark 1 Eyeball”….the visible filthy street index / broken infrastructure)

Another indicator of declining economy, is the ever reducing number of listed companies on the JSE. A decade or two ago, there were more than 700. Today half of that. Wealth has been leaving SA. (Zim has 60 listed companies left on the ZSE).

The title of this article i believe to be rhetorical.

We have the leadership we (the majority) have voted for until destruction (economic) do us part. This is how it plays out in socialist driven regimes time and time again all over the world, have we seen even a glimmer that this time it is different – one could argue quite the opposite.

On a medium to long term timeline, in my opinion RSA bonds are a lost cause. Even if yields are at 30%, what is the point if the R1m you invested is only worth 10% or much less than that in hard currency terms.

Those that do not have the ability, nor the inclination to invest offshore. You are not restricted to economically suicidal ZAR investment policies. Yes your income and costs are in ZAR everyday. What is a pension, it is something that you draw down on to sustain an income and a maintenance of a dignified lifestyle, one which you have worked for all your life and would like to continue.

There are a few things the average retiree can do, i am no expert but would hazard any of these or a combination are multitudes better than placing funds in fixed term ZAR deposits or ZAR bonds.

– take ZAR and place it into a local foreign currency account, probably USD for now
– buy into a mixture of gold shares, if you do not want to then buy into a fund like the Old Mutual gold fund
– buy into physical in the form of a gold ETF

These are all local ZAR investments, however, the moment you purchase them you have in effect converted what will become worthless ZAR into hard currency. If and when the ZAR in the coming years plummets to 100+ to the USD, there will be no need to panic. These 3 will appreciate accordingly and even appreciate at an accelerated pace to the ZAR depreciation.

You can withdraw as required what you need to live your accustomed lifestyle. You do not have to be that individual that had whatever the amount might be – say R1m that is still worth something today, but as you correctly pointed out will likely not buy a can of coke or loaf of bread in 10 years.

The JSE gold index was recently at 6500+. People might laugh at you if you suggest this can and will go to 50,000+ and much higher. However, this will be due to a combination of gold appreciation(regardless of how much authorities try and prevent free ownership) and ZAR depreciation. But it will be you that has the last laugh – yes the path will be very volatile but our government has long since set and started to accelerate that path and trend.

South African bonds do offer higher returns vs. cash which is important for fixed income investors like pensioners. I have invested around 20% of my living annuity in a bond fund, which is not subject to tax on the investment returns earned within the LA. This has provided reasonable return all things considered. I understand the risk that South Africa could start printing money like crazy or default in future, then the rand will be destroyed. This is why I keep 60% of LA invested in international feeder funds. I also have around 70% of my discretionary portfolio invested directly offshore.

Given Government’s precarious finances and no plan – nevermind implementation – to correct things, buying RSA bonds at 10% is dangerous. I need a 20% yield to even consider it.

Ask yourself the question.

Is this the best investment you can do with your money???

And the answer is?????????

End of comments.

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