A li­cence to thrill?

The SA bond mar­ket has the mak­ings of a great in­vest­ment story de­spite the risk, writes Stafford Thomas

Financial Mail - Investors Monthly - - Front Page -

“On March 23, Moody’s an­nounced it was not down­grad­ing SA’s sovereign credit rat­ing to junk sta­tus and had re­vised its credit out­look to sta­ble from neg­a­tive

In­vestors in SA bonds have had rea­son to smile so far this year. They backed what has been SA’s best­per­form­ing as­set class by far.

To mid-April the JSE all bond in­dex romped home to de­liver a to­tal re­turn of 7.5%. It com­fort­ably beat the JSE all share in­dex, which reg­is­tered a 4% de­cline, and trounced the listed prop­erty sec­tor, where prices slumped by 15%.

In­vest­ing in a money mar­ket fund would have pro­duced a re­turn of about 2%.

For bond mar­ket in­vestors it has been a far cry from the sit­u­a­tion they were fac­ing as re­cently as Novem­ber last year, fol­low­ing the gloom-and-doom medium-term bud­get pol­icy state­ment (MTBS) de­liv­ered by for­mer fi­nance min­is­ter Malusi Gi­gaba on Oc­to­ber 25.

His speech sent a shock wave through the bond mar­ket, which re­acted by driv­ing the yield on the key R186 10-year gov­ern­ment bond from a close of 8.8% the day be­fore to a high of 9.44% just two days later.

It was the R186’s high­est yield in two years.

It is im­por­tant to re­mem­ber that when bond yields rise bond prices fall and vice versa.

More bad news came on Novem­ber 24, when Stan­dard & Poor’s an­nounced it had down­graded SA’s sovereign credit rat­ing to non­in­vest­ment ( junk) sta­tus. Only Moody’s was still af­ford­ing SA an in­vest­ment-grade rat­ing, al­beit at its low­est level — Baaa3 — with a neg­a­tive out­look.

A down­grade to junk by Moody’s would have been a huge set­back for the bond mar­ket. It would have re­sulted in SA bonds be­ing re­moved from the do­mes­tic in­vest­ment­grade bond track­ing in­dex and the Citi Bank’s World Gov­ern­ment Bond In­dex, and would have sparked sell­ing es­ti­mated at up to R150bn by for­eign as­set man­agers with in­vest- ment grade-only man­dates.

The gloom that then per­me­ated SA was re­flected in the de­cline in busi­ness con­fi­dence to its low­est level since 1985, the year for­mer pres­i­dent PW Botha de­liv­ered his eco­nom­i­cally sui­ci­dal Ru­bi­con speech.

Then the tide started turn­ing in SA’s favour. The first big pos­i­tive came on De­cem­ber 18 with the elec­tion of Cyril Ramaphosa as ANC leader.

The bond mar­ket’s re­ac­tion was im­me­di­ate: in­vestors pulled the yield on the R186 down to 8.55% by year-end.

The news got even bet­ter on Fe­bru­ary 15, when Ramaphosa was elected as SA’s pres­i­dent fol­low­ing the oust­ing of for­mer pres­i­dent Ja­cob Zuma. It at­tracted more strong buy­ing by for­eign and lo­cal in­vestors. They hauled the R186 yield down to 8.03% within a week of Ramaphosa’s elec­tion.

It was the R186’s low­est yield since May 2015.

March brought more pos­i­tive news for the bond mar­ket. Na­tional trea­sury took it by sur­prise with an an­nounced on March 20 that it was to re­duce the amount of bonds be­ing of­fered at its weekly auc­tions.

In the case of a nom­i­nal bonds auc­tion, of­fers have been re­duced from R3.3bn to R2.4bn, while for in­fla­tion-linked bonds auc­tion of­fers are down from R900m to R600m. It was a clear sig­nal that gov­ern­ment

was de­ter­mined to live up to its promise of re­duc­ing its re­liance on debt and im­prov­ing SA’s fis­cal health.

Matters im­proved fur­ther on March 23, when Moody’s an­nounced it was not down­grad­ing SA’s sovereign credit rat­ing to junk sta­tus and had re­vised its credit out­look to sta­ble from neg­a­tive.

“Moody’s move . . . came as a pos­i­tive sur­prise to the mar­ket,” says Al­bert Botha, a fixed­in­come fund man­ager at Ash­bur­ton In­vest­ments.

The de­vel­op­ment was enough to give the bond mar­ket an­other pos­i­tive kicker, with the R186 yield fall­ing to a low of 7.83% on March 27.

That ap­pears to have marked the end of the win­ning streak, at least for now. The R186 yield has since gone on to re­bound to about 8.1%. “The Ramaphosa po­lit­i­cal sen­ti­ment hon­ey­moon is over, but it’s no train smash,” says Henk Viljoen, head of fixed in­come at Stan­lib.

The re­bound in SA bond yields comes at a time when emerg­ing mar­ket (EM) bonds in gen­eral are out of favour with for­eign in­vestors.

“The stand­off be­tween the US and Rus­sia over US mil­i­tary in­ter­ven­tion in Syria is not help­ing sen­ti­ment,” says Viljoen. The in­flu­ence of for­eign in­vestors in the SA bond mar­ket is sig­nif­i­cant. “For­eign­ers own at least half of SA gov­ern­ment nom­i­nal bonds,” he says.

But de­spite a more risk-off ap­proach to EM bonds by for­eign in­vestors no ma­te­rial dam­age has been done to EM bond prices.

This is re­flected in the largely side­ways move­ment, in a nar­row range, in the JP Mor­gan emerg­ing mar­ket gov­ern­ment bond in­dex since Fe­bru­ary.

An­other area of po­ten­tial con­cern for EM bonds is the trend in US gov­ern­ment bond yields, where the fo­cus is on the 10-year bond.

In­flu­enced by the steady tight­en­ing of mon­e­tary pol­icy by the US Fed­eral Re­serve open mar­ket com­mit­tee (OMC) since De­cem­ber 2015, the 10year bond yield has lifted from a low of just over 2% in 2016 to a high of 3.2% in Fe­bru­ary. It has since eased to just on 3%.

A move in the 10-year yield to much above 3% would be bad news for EM bonds, says Viljoen. But Mal­colm Charles, a fixed in­come fund man­ager at In­vestec As­set Man­age­ment, be­lieves this is un­likely. “The US bond mar­ket is well-priced for the cur­rent macroe­co­nomic en­vi­ron­ment,” says Charles. “The mar­ket is pric­ing in an­other three or four in­creases in the Fed­eral funds rate.”

The OMC has lifted the Fed­eral funds rate — the equiv­a­lent of SA’s repo rate — six times since tight­en­ing be­gan from just over 0% to a cur­rent tar­get range of 1.5%-1.75%.

Vet­eran US bond mar­ket player Bill Gross of Janus Hen­der­son In­vestors shares Charles’s view on the out­look for the US 10-year yield.

In his March mar­ket re­view Gross wrote that 10-year trea­suries “should fluc­tu­ate around 3% for most of 2018. The Fed’s pur­ported three to four [Fed­eral funds rate] hikes this year are likely ex­ag­ger­ated. The US and global economies are too highly lever­aged to stand more than a 2% Fed­eral Funds level in a 2% in­fla­tion­ary world. If more than 2%, a stronger dol­lar would af­fect emerg­ing mar­ket growth and lead to per­haps pre­ma­ture [mon­e­tary] tight­en­ing on the part of the [Euro­pean Cen­tral bank] and other de­vel­oped mar­ket cen­tral banks.”

With the risk of a big jump in US bond yields seem­ingly low, the big ques­tion for SA bond in­vestors is: where are yields headed for the rest of this year? Views are mixed.

“I be­lieve SA bond yields will be stuck in a tight range for the rest of the year,” says Viljoen. “At the R186’s cur­rent trad­ing level in­vestors in bond funds can ex­pect to have earned a to­tal re­turn of about 9.25% af­ter costs in 2018.”

Botha has a sim­i­lar view. “I find it hard to iden­tify fur­ther fac­tors that will drive bond yields lower,” he says.

“SA bonds are now also over­weight in for­eign in­vestor and lo­cal in­vestor port­fo­lios. I ex­pect yields to stay flat for the rest of the year.”

Charles’s view on the prospects for bond yields dur­ing the rest of 2018 dif­fers rad­i­cally from those of Viljoen and Botha. “Peo­ple are im­pa­tient,”

“State-owned en­ter­prises are also in for a huge shakeup fol­low­ing Ramaphosa’s ap­point­ment of Pravin Gord­han

he says. “I be­lieve the mar­ket has just paused af­ter its strong run. There is still a very strong story to be fully played out.”

Charles says peo­ple for­get that Ramaphosa has been pres­i­dent for a short time and has al­ready made many sweep­ing changes for the bet­ter.

Among th­ese is the ap­point­ment of Mark Kin­gon as act­ing head of the SA Rev­enue Ser­vice in March fol­low­ing Ramaphosa’s sus­pen­sion of com­mis­sioner Tom Moy­ane.

State-owned en­ter­prises are also in for a huge shakeup fol­low­ing Ramaphosa’s ap­point­ment of the no-non­sense Pravin Gord­han as min­is­ter of pub­lic en­ter­prises in Fe­bru­ary.

Charles be­lieves SA bonds are still trad­ing at what he terms a “bad gov­er­nance pre­mium” when com­pared with other EM bond yields.

“The pre­mium is be­tween 50 and 100 ba­sis points,” says Charles. “If the pre­mium falls by just 50 ba­sis points the R186 can pro­duce a to­tal re­turn of about 13% this year.”

While the SA bond mar­ket has the mak­ings of a great in­vest­ment story, there are in­vestors who are still not pre­pared to ac­cept the as­so­ci­ated risk. The ob­vi­ous al­ter­na­tive is a money mar­ket fund, where the net yield af­ter fees will be at around 7%.

How­ever, at a mar­ginal ex­tra risk in­come funds are a strong con­tender. The funds in­vest pri­mar­ily in bank and other cor­po­rate pa­per with yields linked to the Jo­han­nes­burg in­ter­bank av­er­age rate.

Viljoen says: “In­vestors can now ex­pect to earn about 8.25% from an in­come fund af­ter fees.”

What­ever in­vest­ment route is fol­lowed, — bond funds, money mar­ket funds or in­come funds — SA in­vestors are in the com­fort­able po­si­tion of earn­ing a real rate of re­turn well ahead of in­fla­tion, which came in at 4% in Fe­bru­ary.

Pic­ture: 123RF — MARIGRANULA


Pres­i­dent Cyril Ramaphosa … his elec­tion as ANC leader on De­cem­ber 18 was a big pos­i­tive for the bond mar­ket

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