SA authorities bond yields could also be down, however they’re nonetheless massively engaging


RYK VAN NIEKERK: Welcome to this Market Commentator podcast – my weekly podcast the place I choose the brains of the main funding professionals in South Africa. My title is Ryk van Niekerk and my visitor immediately is Duggan Matthews. He’s the chief funding officer at Marriott Funding Managers.

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Marriott curiously was established in 1862 and is likely one of the oldest monetary providers companies within the nation. The group has round $35 billion [R513 billion] beneath administration. Outdated Mutual acquired Marriott in 2005.

Duggan, thanks a lot for becoming a member of me. To start with, you might be based mostly simply outdoors Durban in Hillcrest, an exquisite and delightful a part of the nation. I don’t assume there are lots of chief funding managers outdoors Joburg and Cape City, however I suppose know-how has eliminated the borders.

DUGGAN MATTHEWS: Sure, Ryk. That’s 100% correct. I believe we’re one of many few. There are a few asset managers additionally situated in Durban, or within the Durban space, however we’re within the minority. Having stated that, it’s a fantastic place to work in. As you say, know-how permits for versatile working preparations, so persons are working from unusual locations today, I suppose.

RYK VAN NIEKERK: However let’s discuss investments. Marriott is a part of Outdated Mutual, as I’ve stated, and is a longtime asset supervisor, however you might be seen as a boutique inside Outdated Mutual. You describe your funding model as being income-focused. Simply precisely what does that imply, and the way does it differ from different funding managers who concentrate on mounted earnings?

DUGGAN MATTHEWS: Certain, Ryk. It’s a fantastic place to start out, I believe. That earnings focus of ours actually defines the enterprise and differentiates us from the competitors. I believe we’re fairly distinctive in that we do concentrate on earnings, and that’s not saying we don’t concern ourselves about whole return and capital outcomes. We completely do. However we recognise that the last word driver of excellent returns comes from earnings, and earnings progress from investments.

A giant cause for our concentrate on earnings is that we recognise that so many buyers are investing to attract an earnings stream from their financial savings as a result of they’re coming into a post-retirement part.

We predict it simply makes good sense to put money into companies that may produce a gradual earnings stream, in order that it could permit these companies to attract that earnings from their portfolios with out eroding capital – which implies promoting the bonds and the shares that truly produce the earnings, the capital base. And that’s a great way of constructing positive that your annuity will final you for the size of your retirement. On the finish of the day, retirement is an extended story, 20 or 30 years, so that you need to maintain that capital base intact for so long as you possibly can.

RYK VAN NIEKERK: Sure, completely. We obtain many questions each day from our readers, from our radio audiences, and the bulk are from pensioners who’re involved about mounted earnings. We live in a world the place the rates of interest are at all-time lows, together with in South Africa. However after I have a look at your High Income Fund of Funds, which is one in every of your flagship funds, the return over the previous one 12 months [was] 10% whole return, the earnings portion 7.1%. I believe a 10% return over the previous 12 months is definitely phenomenal and beats your individual efficiency over all the opposite intervals listed in your fund reality sheet. That features two years, three years, 4 years, 5 years and since inception. How do you strategy it? What do you put money into?

DUGGAN MATTHEWS: It was a fantastic 12 months for buyers in our Excessive Revenue Fund, in addition to the sister fund, which is our Core Income Fund, each being our flagship funds at Marriott. The rationale for, I suppose, a very good 12 months – which we’re clearly happy to have produced for our buyers – is that Covid and the financial volatility across the Covid disaster, as crises are likely to do, introduced a very good alternative for the fund. That was an enormous sell-off in authorities bonds which occurred in March and April final 12 months.

The end result was the yields on medium-term authorities bonds – the R186, as an example, which is a bond maturing in 2026 – touched 12%.

Clearly, when you think about that money within the financial institution now could be yielding three.5%, you possibly can comprehend the type of magnitude of that chance. We had been nicely positioned to benefit from that chance, and we did. Yields have clearly come down lots since then, which has translated into capital positive factors for buyers. The top end result has been a very pleasing 12 months for our buyers in these portfolios, in our earnings funds.

RYK VAN NIEKERK: What’s the threat profile of this fund?

DUGGAN MATTHEWS: The fund is geared toward, I believe, a reasonably conservative investor, an investor wanting to attract a comparatively excessive degree of earnings from their financial savings; [it] is somebody who can’t tackle an excessive amount of volatility, so is worried about capital losses over a 24-month interval. So ideally the investor ought to have a two-year time horizon. We consider the Core Excessive Revenue Fund is an excellent answer for that kind of investor. The present yield on the portfolio is shut to six% and, in case you take into account money within the financial institution as yielding three.5%, we simply assume it’s a helpful proposition within the present local weather.

RYK VAN NIEKERK: I just lately spoke to Patrice Rousseau from Ashburton just about about the identical matter we’re speaking about immediately. He stated buyers could have a look at an possibility to maneuver from fixed-income to low-equity multi-asset funds, and he doesn’t see this development. Are you seeing a development of buyers shifting from fixed-income to the multi-asset area?

DUGGAN MATTHEWS: I believe what we’ve seen lately, due to the disappointing returns from fairness markets, is a shift maybe out of balanced portfolios with extra fairness publicity into extra fixed-interest-type portfolios, as a result of the returns from money and bonds have been considerably higher. In order that’s the development we’ve seen lately.

RYK VAN NIEKERK: We’ll see a finances announcement this week and we count on very, very unhealthy information. I believe the shock will probably be if the unhealthy information just isn’t as unhealthy as many individuals count on. How do you assume that may have an effect on markets, particularly the earnings markets?

DUGGAN MATTHEWS: It’s going to be an vital announcement for the bond markets. I believe you make a great level there. There’s a lot unhealthy information priced into South African authorities bonds that despite the fact that it may doubtlessly be not a really constructive finances, a finances clearly exhibiting some monetary stress on the a part of the SA authorities, I believe most of that unhealthy information has been priced in. And also you would possibly discover that as a result of the South African economic system has been a little bit bit extra resilient – we’ve had a rebound in commodity costs – that the expectation the markets have will probably be doubtlessly overly pessimistic.

Our expectation is that the finances might be going to exceed these expectations, which is prone to be fairly constructive for South African authorities bonds.

I believe the fact is, in case you have a look at the pricing of bonds, a lot unhealthy information is in that value. On account of that, we’ve acquired a scenario the place our bonds are providing among the many highest actual yields on the planet, and one of many steepest yield curves as nicely on the planet. So I believe there’s extra upside potential going ahead than draw back potential, for positive.

RYK VAN NIEKERK: As you’ve stated earlier, we’ve seen a major strengthening of bond charges from the R186 being at over 12% and at present round 7%. The 10-year bond has additionally strengthened considerably. And that’s put up a downgrade to junk standing by Moody’s and the opposite companies. We’ll in all probability see extra downgrades this 12 months, which is not going to be a shock because of the weakening fiscal place of the state. Are you involved about score companies and the scores of our bonds?

DUGGAN MATTHEWS: No. I believe, as soon as once more, it’s within the value. If you concentrate on the yield backdrop globally, 25% of worldwide bonds are yielding unfavorable rates of interest. So in case you put your cash in bonds, you’re going to get a unfavorable return in case you maintain them to maturity. That doesn’t even bear in mind inflation. The yield of the US inflation-linked bond in the intervening time is sitting at -1%. Within the UK for a UK 10-year inflation-linked bond it’s sitting in -2.eight%.

So though our yields have come down, they nonetheless stay massively engaging relative to what’s accessible in the remainder of the world. I’ve talked about that they’re among the many highest on the planet. They do include further threat. After all they do. However I believe if an asset supervisor can handle that threat sensibly, buyers searching for earnings are going to battle to discover a higher place.

And from our perspective, to handle that threat of a possible authorities default, we’d keep on with authorities bonds with maturities lower than 10 12 months, as a result of though we do assume we’re not on a fantastic path from a fiscal sustainability perspective, we nonetheless assume it’s going to take lots of time earlier than we finally find yourself at that time.

RYK VAN NIEKERK: The phrase “default” simply despatched a shiver down my backbone. However you additionally stated managers ought to handle their portfolios “sensibly”, which is an attention-grabbing time period for an asset supervisor. What do you imply by that?

DUGGAN MATTHEWS: I simply assume you’ve acquired to be cognisant of the dangers. You don’t need to find yourself in a scenario the place you might be reaching for yield. So that you need to attempt to obtain a great yield, however you need to ensure that the danger of disappointments and capital volatility is minimised. And when you think about that South Africa is on a tough path from a debt-sustainability perspective, for us that negates very long-term authorities bonds from our investible universe. We’re not excited by lending to the federal government for intervals of 10 years or longer.

Our most popular authorities bonds have a maturity profile of simply over 5 years, as a result of we expect inside that framework, that time-frame, you’re going to select up a very engaging yield, and the potential of any defaults inside that time-frame may be very, very distant.

So that’s how I believe you possibly can go about sensibly utilizing the federal government bond market to attain good outcomes for buyers.

RYK VAN NIEKERK: Duggan, we live in a really attention-grabbing interest-rate surroundings – not solely domestically but additionally internationally – the place charges are at all-time/file lows. Now, many individuals who dwell on fixed-investment merchandise actually battle. Let’s use an instance of a 60-year-old pensioner who has R1 million accessible to take a position. The individual is, nonetheless, very involved about capital preservation, however wish to see the next yield. What would your recommendation be for such a person?

DUGGAN MATTHEWS: After all it at all times pertains to the danger urge for food of the investor, and the way a lot volatility they’ll abdomen. However I believe the fact is that, in case you’re not going to tackle any length threat, or market threat in anyway, and also you’re going to simply find yourself in funds very near money-market autos or cash-type funds, the return outlook for these forms of portfolios just isn’t good in any respect. I imply, you’re going to be fortunate in case you get four%.

So I believe these buyers are going to have to contemplate perhaps taking over a little bit bit extra threat from a volatility perspective. However, having stated that, that doesn’t imply you need to have a look at high-risk investments. We nonetheless assume a five-year authorities bond is a really low-risk funding within the context of South Africa. And there you will get considerably higher returns than you possibly can with cash sitting in a checking account.

And keep in mind, one additionally wants to grasp that authorities bonds are safer than financial institution deposits as a result of on the finish of the day governments bail out banks and never the opposite manner round.

So I believe there is a chance for retired buyers who want to attract a comparatively excessive degree of earnings to perhaps begin fascinated about not having all their cash in money, however trying to embrace some shorter- to medium-dated authorities bonds of their portfolios in order that they’ll get the next yield, and draw extra earnings from their financial savings safely. Basically that’s what our Core Revenue Fund and Excessive Revenue Fund are all about.

RYK VAN NIEKERK: What do you assume is a practical expectation for extra yield in case you transfer from money to an earnings fund?

DUGGAN MATTHEWS: That’s a very good query, Ryk. I believe in case you’re taking a look at four% returns in your cash-type investments, if you’re ready to put money into devices with a bit [of a] long term, resembling these bonds that we’ve been chatting about, you possibly can push that return as much as about 6% or 7%, in addition to a yield of about 6%. You’ll have a bit extra volatility, however in case you’re there for 2 years and you’ve got that kind of time horizon, the likelihood of reaching a 6% to 7% return and a 6% degree of earnings may be very, very excessive in our opinion.

RYK VAN NIEKERK: The volatility is attention-grabbing, particularly in an earnings fund. Would that be volatility in capital values, or in precise returns?

DUGGAN MATTHEWS: It will likely be short-term volatility in capital values, however very, very low compared to the kind of volatility that you’d see in fairness portfolios or balanced portfolios. Minimal volatility, however volatility nonetheless, as a result of in case you distinction that to money-market funds, there’s clearly zero volatility in these forms of portfolios. However the trade-off may be very, very low returns.

So we expect at this cut-off date it is sensible to perhaps tackle a little bit little bit of volatility, make investments outdoors of pure money deposits, have a look at these excessive yields on provide by authorities bonds, be smart by proscribing the time period that you simply exit to, to across the five-year mark – and you’ll obtain a great end result, regardless of the very low money charges in South Africa.

RYK VAN NIEKERK: Simply lastly, I’m taking a look at your present asset allocation of the Excessive Revenue Fund of Funds. As you stated earlier, round 50% of the portfolio is in authorities bonds. However I additionally see that you simply solely have zero.6% invested in actual property funding trusts. Prior to now listed property was a fantastic asset class. It has carried out poorly lately owing to the poor efficiency of our economic system. Are you wanting on the property sector? Do you assume there may be worth and potential yield on provide?

DUGGAN MATTHEWS: We in all probability see a little bit of worth there, however that sector is beneath a lot strain, and there’s a lot uncertainty with regard to the outlook of that sector. We’re seeing unfavorable rental reversions and there’s an oversupply of area. In order that’s why you’ve seen that 50% allocation in bonds. What we need to do is we’re going to take that yield, we need to maintain that instrument to maturity, and we need to come down the yield curve which ends up in capital appreciation. On the finish of the day you possibly can obtain much more predictability utilizing bonds in an earnings portfolio, versus listed property. And therefore our desire for [bonds].

RYK VAN NIEKERK: Duggan, thanks a lot in your time immediately and thanks for sharing your insights.

DUGGAN MATTHEWS: Pleasure, Ryk. Thanks for having us.

RYK VAN NIEKERK: Duggan Matthews is the chief funding officer at Marriott Funding Managers.

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