Wikus manages a range of fixed interest portfolios, which include the Income Fund, Enhanced Income Fund, Namibia Enhanced Income Fund and the fixed interest component of the Real Income Fund.
Wikus joined Old Mutual Investment Group in October 1999 as a fixed interest portfolio manager from ABN AMRO Securities. He started his career in the Economics Department of the South African Reserve Bank. In 1995, he joined ABSA Bank Treasury as a treasury economist and pursued this position until 1997.
Old Mutual Namibia Enhanced Inc comment - Sept 18
The third quarter of this year was particularly cruel for emerging markets, especially due to the barrage of persistently negative news flow from Turkey and Argentina. This was in addition to existing headwinds like the escalating risk of more international trade restrictions between the US and key trading partners, which, if it comes to fruition, may have potentially dire consequences for emerging markets. As market sentiment turned sour, foreign investors predictably responded by becoming large-scale sellers of emerging market bonds and currencies.
In the case of South Africa, foreign investors sold R17 billion of rand-denominated RSA government bonds over this period, contributing to net sales of just short of R60 billion for the first nine months of this year. Although dwarfed by the excessively sharp depreciation of the New Turkish lira and Argentine peso, the rand, like most other emerging market currencies, failed to escape the carnage as it depreciated by around 11% against the US dollar from the end of June to early September. In the process, the local currency has reached its weakest level against the greenback since June 2016. Although the rand retrieved some lost ground during the last three weeks of September, it is still about 20% weaker from its best level this year. This, in turn, contributed to heightened market fears of additional future inflationary pressure and a possible rate increase by the South African Reserve Bank (SARB). Although the SARB thus far resisted the temptation to hike its policy rate, it did utilise every single opportunity to warn against the risks to higher inflation, which implies higher future rates should the rate of inflation indeed accelerate too fast for its liking.
While negative international developments had been prominent, local data releases also contributed to negative market sentiment. The rate of inflation at both consumer and producer levels continued to tick higher, with the latter now just outside the top end of the inflation target range. Most disappointing had been the release of gross domestic production data for the second quarter of this year, which confirmed a 'technical' recession; that is, a negative growth rate for two consecutive quarters. From a bond market perspective, it is noteworthy that weak economic growth could hamper tax revenue collection, particularly corporate income tax, and if unmatched by expenditure cuts, risk fiscal consolidation. This, in turn, would lead to a higher funding requirement and possibly more sovereign credit rating downgrades. Luckily so far, the latest available data shows that South Africa’s cumulative main budget fiscal deficit for the first five months of the 2018/19 fiscal year is still largely on track relative to the Budget presented in February this year.
The events described above not only forced bond yields across the yield curve to higher levels, but it also contributed to significant intra-quarter volatility. The extent of this volatility is demonstrated by the trading range of 8.57% to 9.25% of the benchmark R186 (maturity 2026). A late-quarter relief rally caused the R186 to gain some lost ground, but it still closed the quarter 15 basis points (bps) higher at 8.99%. The net increase in yields during the quarter led to a disappointing JSE ACSA All Bond Index (ALBI) return of 0.8%. Although the inflation-linked bond market initially failed to escape negative market sentiment, real yields stabilised at the higher levels towards the end of the quarter, bringing to an end the sharp rise in real yields that started in April this year. As a result, the JSE ACSA Government Inflation-linked Index (IGOV) returned only 0.5% for the quarter. However, this was a significant improvement considering the second quarter return of -4.6%. Cash retained the top position for the period under consideration, returning 1.6%.
Investment view and strategy
The recent, more sustained pick-up in global bond yields notwithstanding, our view remains that most developed bond markets are still not appropriately priced. In the case of the US, the strong pace of economic growth, the low level of unemployment, and evidence of sustained higher inflation support further US monetary policy tightening. We believe that the Federal Reserve is in a position to lift its policy rate by at least another 25bps this year. More importantly, at a global level, the trend continues to gradually shift from quantitative easing to quantitative tightening.
Locally, our main concern with regards to the bond market remains the strong link between lacklustre economic growth and fiscal consolidation - or more specifically, the rising debt burden of Government, which arises as a consequence of a lack of fiscal consolidation and therefore continues to threaten the country’s sovereign risk profile. The risk of a failed economic recovery has risen following a slew of disappointing data releases the last few weeks. This makes us question the quality of tax revenue collections, which in turn keeps the risk of a budget deficit overrun at elevated levels.
On the monetary policy front, we maintain our view that the central bank will remain hostage to the opposite forces of a lacklustre economic growth outlook and upside risks to inflation. For now, to us this suggests a stable policy path. The risk to this view is skewed in favour of some upside risk to inflation and thus interest rates.
While the observable investment theme and related realtime developments mostly have negative consequences for the local bond market, it is important to note that current market valuation is largely reflective of this. Cheaper market valuations following the sell-off during the second and third quarters of this year afforded us an opportunity to cautiously increase risk by selectively buying nominal bonds. We shall continue to look for opportunities to increase bond market exposure, but only into bouts of weakness, considering the level of uncertainty discussed above.
The fund outperformed the benchmark on a net basis for the 12-month period ending September 2018. The negative contribution from an underweight exposure to the best performing long-dated nominal bonds was more than offset by the contribution from high-yielding variable rate bonds.
The fund is conservatively positioned, with an underweight modified duration position, a large holding of relatively stable variable rate bonds as well as exposure to fixed rate money market instruments with a term to maturity of less than 12 months. We have utilised recent market weakness to increase fund exposure to short-dated inflation-linked bonds.
We shall continue to look for opportunities to invest in low duration, higher-yielding non-government variable rate bonds with a focus on steady accrual accumulation, while avoiding the potentially negative impact of excessive interest rate volatility. That said, we shall keep an eye on the level of nominal yields for the potential cautious accumulation of medium-dated fixed rate government bonds. The same applies to shorter-dated inflation-linked bonds.
This actively managed fund invests in a wide range of Namibian and South African interest-bearing assets (for example, money market instruments, bonds, listed property and preference shares). The fund manager moves actively between these assets, based on a relative value approach.
With no restrictions on the average duration of the portfolio, the fund may hold both short- and long-term securities. This gives greater flexibility in taking advantage of interest rate trends and thus to maximise capital gains and income yields. Interest income can be reinvested to generate further growth, or paid out to supplement income. With a secondary focus on capital gains, the fund will maintain a high quality bond exposure and seek out listed property companies showing good prospects for growth and yield.