Consider your options for domestic assets
Rate cuts boost performance of fixed-interest assets
THE South African Reserve Bank’s decision to cut the repo rate by 50 basis points recently came as a surprise to many in the investment fraternity. The Bank’s move was not only welcome but necessary to add impetus to the struggling economy. While SA unofficially emerged from recession in the fourth quarter of last year and growth is likely to accelerate, recovery remains fragile.
Interest rate-sensitive assets reacted positively to the unexpected rate cut. The listed property sector also benefited from the move with a return of 2,2% for the week. However, the most important question remains: what are the prospects for domestic fixedinterest assets?
Foreigners have still been relatively big buyers of South African bonds this year, with net foreign purchases totalling R12,7bn. Foreigners are notoriously fickle investors and, with the latest rate cut, the local bond market has become less attractive. There is also a very real threat of the global economy going into a doubledip (W-shaped) recession due to, among other things, China’s tighter monetary policy over the past few months.
While lower growth traditionally leads to lower bond yields (and rising capital values), this is not necessarily the case with bonds in emerging markets, as yields rise when global economic growth slows and vice versa. Emerging market economies are highly geared to the global economy and commodity prices. During global economic downswings the risks of investing in these economies increase, as downside pressure mounts on important economic variables such as their current accounts and currencies. If global growth should stall this may well spark a big sell-off in our bond market by foreigners.
The yields on domestic bonds are higher than the money market — the current yield on the All Bond Index is 9,0% versus the money market’s 6,5% or less. However, neither asset class looks too attractive right now, especially on an after-tax basis. With the risk of capital losses on bonds also a potential risk, fixed-interest investors should stick to flexible income funds, where the portfolio manager actively manages the maturity of the portfolio and strives to limit capital losses. Another fixed-income option is a portfolio of variable-rate preference shares. These shares pay dividends, the rate of which is linked to the prime interest rate. Most of these shares still offer a higher yield than the money market and they have the added benefit of tax-free dividends.
Preference shares are still trading at a discount to their original issue prices, which results in an increase in the effective yield. Preference share prices vary, but price volatility does not influence the investor’s income stream as dividends are based on issue prices and not market prices.
The last option for investors is property that offers an income stream comparable to bonds but with potential for much higher growth (or losses) in capital value. While the recent interest rate cut should boost economic growth and prospects for improvement in the property market, the prices of property instruments have experienced equity-type volatility in market corrections. If a double-dip recession materialises, listed property instruments will be affected negatively. Only investors with a time horizon of at least three to five years should consider an investment in listed property.