Allan Gray Bond comment - Jun 19
North is seldom obvious in the midst of a storm, but the future direction of investment markets feels particularly uncertain. One indication of this uncertainty is that it has become surprisingly easy to provide compelling arguments for diverging bond views.
Global bond bulls argue for lower yields for longer due to deflationary demographic, debt and technology trends. On the other hand, bears point to current abnormalities, such as negative bond yields, a boom in junk-rated corporate credit and overconfident central bankers. South African bond bulls focus on high real yields, stable inflation and excessive pessimism. Just as convincing, South African bond bears have an armoury of ammunition following South Africa’s decade of economic divergence: high government debt, bankrupt and incompetent state-owned enterprises, negative per-capita economic growth and deteriorating intellectual, political and physical capital, to name a few.
Given the right advocate, all of the above arguments make sense. It is, however, unlikely that divergent outcomes will remain equally probable. Instead, reality is likely to deteriorate or improve, with different investment consequences. Unless one has a crystal ball, investors are being asked to ''pick their poison'' and accept the associated pain, should the future turn out different.
Our poison is to position the Fund for the middle path, despite this being the least probable actual outcome. By doing so, we accept that the Fund will likely underperform on a relative basis if the bond bulls turn out to be right, or experience poor absolute returns if the bond bears are correct.
We have chosen this path because we cannot predict future macroeconomic outcomes. Instead, our goal is to improve the probability of reasonable absolute returns across a variety of scenarios. Practically, this means the duration of the Fund is lower than the All Bond Index, the average yield of the Fund is close to the Index yield, and a high percentage of the Fund remains invested in liquid money market instruments and government bonds to allow the Fund to respond to opportunities.
Duration was marginally lowered over the quarter. The most notable development was steepening of the South African bond curve as the market priced in short-term interest rate cuts, while long-term rates bore the brunt of weak fiscal conditions. For some time, we have believed longer duration bonds offer the best relative value. In hindsight, this turned out to be a mistake or too early. The recent curve steepening further reinforces our preference for a combination of long-duration government bonds, short-duration money market, and mid-duration fixed-rate corporate credit.
New appointments We recently welcomed two new fixed-income portfolio managers: Thalia Petousis and Londa Nxumalo. Thalia has over seven years’ experience in fixed interest and joined Allan Gray in 2015 as a fixed-interest trader. She will co-manage the Allan Gray Money Market Fund. Londa also has seven years’ investment experience and joined Allan Gray in 2017. She will co-manage the Allan Gray Bond Fund. Both managers have proven to be invaluable members of the investment team, and their expanded roles will allow our clients to benefit further from their expertise.
Commentary contributed by Mark Dunley-Owen
The Fund invests in South African interest bearing securities. Securities include national government, parastatal, municipal, corporate bonds and money market instruments. The Fund price is sensitive to interest rate movements because of the long-term nature of the Fund's investments. The duration of the Fund may differ materially from the benchmark. The Fund is managed to comply with investment limits governing retirement funds.