RYK VAN NIEKERK: Welcome to this market commentator podcast. It’s my weekly podcast, where I speak to leading investment professionals. My name is Ryk van Niekerk, and my guest today is Albert Botha, the head of fixed-income portfolio management at Ashburton Investments.
Albert, thank you so much for joining me. Fixed income is a significant topic currently. The Reserve Bank has cut interest rates to the bone this year; they are currently at the lowest level in close to five decades, and it has resulted in the yields of many fixed-income and money-market products dropping significantly. What returns can investors expect from these funds in the current market environment?
ALBERT BOTHA: Fixed income is interesting, at least for guys like myself. I know a lot of other people find it a bit dry. The returns you can get from these portfolios vary significantly, depending on the type of portfolio. An equity fund to a large degree can be compared with other equity funds. However, within fixed income, the range is quite wide.
Right at the bottom end of the spectrum, you have effectively your money-market portfolios. Your money-market funds will give you approximately 1% above the repo rate over any 12-month period. So, if the repo rate averages, let’s say, 3.5%, the money-market fund over a 12-month period will give you about 4.5%. That’s after all investment fees. It doesn’t take into account if there are advisor fees or not.
Then you can move all the way to the other end of the spectrum, your bond funds. Here you can invest in instruments that are currently yielding anywhere up to 10% or above. Right now the volatility and the risk in those instruments are significantly different from what you get in a money-market portfolio. You are sitting in that space, depending on how much risk you’re taking.
In the last couple of years, most clients have moved into both money-market type portfolios or what’s deemed enhanced money-market, enhanced-cash, or enhanced-yield portfolios. These are portfolios like our Ashburton Stable Income Fund, which over a 12-month period should get you about 1% above money-market funds, so about 2% above repo. So if the repo rate average is 3.5%, these portfolios should give you approximately 5.5% after all investment fees.
RYK VAN NIEKERK: That is interesting, because currently at banks the fixed-deposit rates are very similar to those. I would assume many people would look at such fixed-deposit rates as less risky than money-market and fixed-income funds. How should an investor look at those options?
ALBERT BOTHA: Well, we quite often see various stock and investment products as being equal. I think a much better way of looking at it is realising that you should try to select a product that matches your needs. One of the primary features of unit-trust funds or collective-investment schemes is that for now these instruments or these portfolios offer you liquidity on a T+1 or next-day basis. So, if you put your money away today and three days later you want it, you can get it. If you put your money away today, and seven months later you want it, you can get it. It has a degree of liquidity that’s not available within a fixed deposit.
That doesn’t mean that all investors should be in money-market funds all the time. Occasionally, depending on your need, a fixed deposit for a proportion of your money can be part of holistic planning [strategy] that you can look to, to invest your money.
I think that, much like you want to diversify asset classes though, you may want to look to diversify solutions as well – because, given the uncertain nature of our economy, if you lock away all of your money for a five-year fixed deposit and you need emergency funding three weeks from now, then there are breakage fees and those kinds of things, and they can start becoming expensive.
So people tend to combine these various things to get to an outcome that’s more suited to them.
I think the way to look at it is to ask yourself, “What do I need this for? Is this money that I made from selling a house or selling a flat that I may want to move into the market, or that I may want to move offshore if the rand strengthens?”
Then a money-market fund probably suits you better, as you may need that liquidity on any specific day. You don’t know when that is.
If this is money that you are saving to buy something five years from now, or if you know you’re not going to need it, then a fixed deposit might also work well. But in practice, people tend to use a combination of these things.
RYK VAN NIEKERK: It’s also a way to preserve capital. As you’ve said, we’ve seen volatile markets, especially equity markets, since the beginning of the year. We’ve had some big, big swings and many people are concerned about capital preservation. Have you seen – especially in recent months, where we have seen a strong recovery from the lows in March – a significant inflow above normal into your Fixed Income Fund?
ALBERT BOTHA: We’ve seen significant flows in specifically our Money Market portfolio. The Money Market portfolio is managed by two of my colleagues, Khothatso Nyabela and Mohamed Ismail. That portfolio specifically is invested only in the big five South African banks, National Treasury people’s short-term paper, and AAA-rated international banks. So it’s a portfolio that’s constructed to be effectively free of non-bank credit risk. And, from the end of December until effectively the end of this month, the fund grew from just under R4 billion to about R9.5 billion. So we’ve seen some significant flows in that kind of space with people rushing towards safety.
But, at the same time, we’ve also seen some clients moving out of call and overnight accounts, and moving more and more money into a money-market space.
I think that’s a trend we’re likely to continue seeing for the next couple of years while interest rates remain low – clients moving one or two steps up the risk curve as they require a higher rates of return to meet their investment goals.
RYK VAN NIEKERK: How have the significant interest-rate cuts affected the performance of the funds?
ALBERT BOTHA: The Money Fund and the Stable Income Fund, aren’t really affected significantly on a mark-to-market basis. In other words, even if the fund doesn’t lose capital as a result of interest-rate cuts, what does happen is that – just like with your home loan or your car loan – the rate of interest that the fund earns looking forward drops. When the repo rate was at 6.5%, Stable Income was giving you 8.5% forward deals.
Now the repo rate has dropped to below 4% – it’s at 3.75%, 3.5% – and now Stable Income is looking to give you 5.5% forward-looking rates. So it’s a reduction in the forward yield, the expected return of the portfolios, rather than a variation or a loss in capital that you see in these funds. Stable Income, for example, hasn’t had a negative month in over the last decade, and the Money Market Fund hasn’t had a negative month at all since its launch.
RYK VAN NIEKERK: But I’m looking at the Stable Income Fund. The year-to-date yield is around 2.7%, and on the Money Market Fund the year-to-date yield is around 3.2%; that’s not significantly higher than inflation. It also doesn’t fit in with those forward yields you’ve just mentioned. How do you explain that?
ALBERT BOTHA: If we look at the last inflation print, till the end of June, the one-year inflation up to June was about 2, 2.1%. The one-year return from the Money Market Fund up until now, which is the end of June, for the past 12 months, over that same period was inflation of 2%. I’ll have to double-check, but I’m pretty sure the Money Market Fund return was in excess of 7%. So it actually outperformed inflation quite handily. One of the advantages of living in South Africa is that our interest rates are still real. We still have interest rates that are above inflation across the curve – at least for now. And from the comments of the Governor of the Reserve Bank, that’s a policy that’s likely to be maintained.
On a forward-looking basis, those real yields start dropping away. But the year-to-date number is only for six months. In other words, you have the June fact sheet, so you’re comparing six-month returns with a full year’s worth of inflation. So there’s a little bit of a mismatch.
RYK VAN NIEKERK: Yes. I see the one-year performance is nearly 7%, as you’ve said. On the Income Fund and on the Money Market Fund it’s over 7%. So that is significant. And again, if you look at the equity market currently, which is down year to date, these are very attractive yields.
ALBERT BOTHA: Yes, they are. South Africa is, as I said earlier, fortunate about our yield environment. There are risks in South Africa, true; but, if you look at the ECB [European Central Bank], the Bank of Japan, the Fed or the Bank of England – all of them have either zero or close to zero interest rates. The current yield on a 10-year bond in the US is 0.5%. In other words, the annualised rate of interest you’ll be earning over a 10-year period is 0.5%. The South African 10-year bond is currently yielding 9.4%.
We are being rewarded in South Africa for investing within the fixed-income asset class. It is not quite unique, but a somewhat favoured position to be in globally.
Our equity markets, however, have struggled the last couple of years and, given the current view on South Africa’s economic growth forecasts, are likely to continue to struggle for at least the foreseeable future.
So, for example, should you ask just a broader house-view question, at Ashburton we tend to prefer global equities over local equities; but we tend to prefer local fixed-income over global fixed-income. So if you think about that Stable Balanced Fund type portfolio, we tend to have more of our fixed-income assets in South Africa, where they can earn between, let’s say, 5 and 9%, rather than offshore where they can earn less than 1% – whereas we have more of our equity or we tend to favour offshore equities, where there’s a more attractive growth environment than perhaps in South Africa, where the equity growth environment is less attractive.
RYK VAN NIEKERK: The Money Market Fund, as you’ve said, has more than doubled over the past few months, to over R9 billion under management. Do you see any significant foreign investment into these funds?
ALBERT BOTHA: Not at the moment. Most foreigners, when they do participate in the South African market within the fixed-income space, participate more in the bond market. One of the interesting things that we’ve seen in the past couple of years is that, if you look back to, say, 2016, the rate that you could get on a one-year cash instrument, the one-year NCD [Negotiable Certificate of Deposit] and the rate that you could get on a 10-year bond were both just above 8%, so you weren’t really being rewarded for taking on either term risk or duration risk. With the additional nine years you’re taking on with government debt you weren’t really being rewarded.
That same equation now is you’re getting about 4% for investing in one-year bank NCDs; you’re getting about 9.4% for 10-year government bonds. So foreigners who look towards South Africa – and they are to some extent either taking some or a lot of currency risk by investing here – want to be rewarded in the most optimum way, and taking bond risk with a little bit of term, in other words buying debt instruments at of 9% rather than 4% suits their books a lot better. So we’re seeing more participation in that space than we are seeing in the money-market space.
RYK VAN NIEKERK: The Reserve Bank has entered the secondary bond market. Does that affect you at all?
ALBERT BOTHA: The Reserve Bank has been very careful about its participation in that secondary market. We know that there are some ideological calls. It has been asked to intervene more with what in the U S and in Europe is effectively funding South Africa’s market debt. And the Reserve Bank has been very careful to say that its participation in the South African secondary market is not intended to be quantitative easing. It does not have a buying target, and is on target in yield levels. It is entering the market in an effort to promote liquidity. What that meant was that during especially March and April buying and selling bonds became quite expensive.
To understand what that means you’ve got to understand how bonds trade. Generally, when you ask for a bond price, you get a buying price and a selling price. And the less liquid a market becomes, those buying prices and selling prices start to move away from each other. So trading them becomes expensive. By entering the market and helping to provide liquidity, the Reserve Bank has helped move those prices closer to each other. Let’s call it “liquidity backstop”. The liquidity provision has helped the market in its smooth functioning. The Reserve Bank has not – as many have either feared or hoped for – entered an aggressive buying programme to buy a lot of South African government debt. So that hasn’t helped from a level perspective, but has helped the smooth operation of the market.
RYK VAN NIEKERK: How often do you trade within these funds? Is it quite often, or do you take long-term views?
ALBERT BOTHA: It varies quite a lot on the type of portfolios, and what’s going on in the market around us. The South African credit market – which is the market where a portfolio like the Stable Income Fund invests primarily – is somewhat different from what you read in textbooks when you study investing in that trading it, trading in credit, is not as easy as people would have you think. The Stable Income Fund, for example, is mostly buying credit and then holding it to maturity, so there’s very little trading actually going on. It’s mostly buying and holding to maturity – so very long-term three-year, five-year views of companies.
The Money Market Fund, by the nature of what money-market funds have to look at, has a shorter turnover period. But that’s because regulation forces us to have a weighted average term of all instruments to be less than 120 days.
And then the Bond Fund and the kind of multi-asset income fund – called the Ashburton Diversified Income Fund – go through periods of heavier trade when there is more market uncertainty. So, for example, we traded very heavily in March and April, and then we traded significantly less in June. But there is quite a bit more trading in those portfolios, and the reason is that they invest in asset classes that allow you some more liquidity. There’s some property in there, there are some preference shares in there, and about 20% of that fund is invested offshore in US dollar asset classes. And that allows you to do some trading there as well.
But Ashburton as a house has more of a macro-investment style, rather than an active trading style, or a quant style, or a high-frequency trading style, depending on how many Michael Lewis books you’ve read. So it’s much more a longer-term investment horizon than a short buy-today-and-sell-tomorrow type of trading style.
RYK VAN NIEKERK: Of course you are linked to FirstRand. Do investments you make form part of the bank’s capital-adequacy ratios?
ALBERT BOTHA: No. Ashburton’s surety is wholly owned by FirstRand, much like FNB and RMB and the other brothers that are significantly larger than we are. We are a relatively new asset manager in South Africa, having been around I think for about six, seven years. While we are wholly owned by the FirstRand holding company, we’re not owned by the bank. So we’re not owned by FNB or RMB, and all of our assets are off balance sheet. So none of our assets in the portfolios form part of the bank. That means it’s bankruptcy-remote. All your assets are held in trust, or by custodians. We’re not involved in the Basel calculations. None of our portfolios are involved in the Basel calculations or the capital-adequacy calculations for the banks.
RYK VAN NIEKERK: God forbid we see a bankruptcy in our banking sector in the foreseeable future. Albert, thank you so much for your time today. That was Albert Botha, head of fixed-income portfolio management at Ashburton Investments.