EXCHANGE-TRADED FUNDS

In a risky and inflationary environment, what are the investor’s choices?

ou wouldn’t have made much if you’d been invested in government bonds last year — or any of the local exchange traded funds (ETFs) that track them. But you wouldn’t expect to in an environment where inflation is accelerating and is set to hit 7% in the months ahead. So what’s the risk-averse investor to do: cash in and sit out the big swings in equities, which also haven’t delivered much over the past year unless you were invested in rand hedges, which did well thanks to the rand’s fall from grace?

There are other options; in fact there are quite a few. If you want to stick to the safety of government debt — assuming it is safe — inflation-linked bonds may be the way to go. Not only have they outperformed other government debt over the past year, but over the longer term they’ve also done a lot better.

Data from etfSA shows that over five years inflation-linked bonds have delivered about 9% a year and fixed-interest bonds about 7.5%. Over 10 years, inflation linkers have delivered about 11% a year; fixed-interest bonds have still lagged at about 7.5%. That’s not bad for a relatively risk-free investment.

Returns are lower than you might achieve on the stock market as you don’t get the capital gains, but you also won’t sustain the losses that you potentially could face in equities.

Barclays Africa’s ETF head, Michael Mgwaba, says nominal bonds are fine when inflation is retreating, but in current circumstances you want the hedge that inflation linkers provide. He also argues that bonds aren’t just for the elderly or those nearing retirement; they should be part of any balanced portfolio, as should cash. etfSA MD Mike Brown says they protect the real value of your money.

Barclays Africa offers bond ETFs, including the Ilbi and the Govi, under its NewFunds label. It also offers the Traci 3 Month ETF, a money market instrument that has delivered about 6% over the past year. That’s better than most money market funds, partly because it has a very low total expense ratio (TER) at 20 basis points. Mgwaba suggests including it in your portfolio for the longer term, but Brown says it’s a good place to park cash in the shorter term too. It pays products. I’ve written previously about the spectacular returns Deutsche Bank’s db X-trackers have delivered over recent years, as much due to rand weakness as rising equity markets, but some investors may not have the stomach for the stock market this year. The NewWave notes have also done pretty well, with the dollar note delivering 25% over the year to March 10, while the euro note increased by 28% and the sterling note by 18%. Interest is paid twice a year and you get your capital back on redemption. Of course, you do run the risk of the rand going the other way this year, particularly if our finance minister can convince investors and ratings agencies that we’re worth our investment grade.

Brown says the currency ETNs are not as well known as they should be. Your money is invested in a money market fund — in rands, so you’re not using your offshore investment allowance. The expense ratio is also low, particularly compared to buying foreign exchange at a bank. These give you rand hedge protection, without equity risk.

A couple of other options are property ETFs. Property shares should give protection against inflation, assuming that rental increases keep pace. Brown says he’s also seeing signs of life in PrefTrax, the CoreShares ETF that tracks the JSE preference share index. Preference shares pay an interest rate based on prime and shareholders are first in line for dividends from issuers, which are mostly banks. Prefs tend to trade at their par value, but for some time have been trading at a discount of about 15%, says Brown. Some issuers have started recalling their prefs, particularly now that they are no longer regarded as equity for the Basel capital requirements. So investors can get in at a discount and can redeem them at par if the banks call them in.

Property shares should give protection against inflation, assuming that rental increases keep pace