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

Financial Mail - Investors Monthly - - Contents -

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

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