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Dynamic solution to changing market conditions

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While many investors can match multi-asset funds with riskier balanced funds, which can hold up to 75% in equities, there are also multi-asset funds with more moderate risk profiles and a lower allocation to equities. actions. These funds provide a dynamic solution to changing market conditions, while remaining aligned with the stated objective of the fund.

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While many investors can match multi-asset funds with high-risk balanced funds, which can hold up to 75% in equities, there are also multi-asset funds with more moderate risk profiles and lower allocation. to actions. These funds provide a dynamic solution to changing market conditions, while remaining aligned with the stated objective of the fund.

Multi-asset funds offer an attractive alternative to more conservative income-seeking investors who are willing to tolerate additional volatility. While these funds can traditionally add stakes in different asset classes (stocks, cash, bonds and real estate), we have noted the exceptional rise offered by SA government bonds. As a result, our current holdings of nominal and inflation-linked government bonds are moving well above their long-term average levels in our portfolios.

SA government bonds

We are well aware of the precarious budgetary situation in which South Africa finds itself. However, it is important to put the fears surrounding the government’s budgetary situation into perspective. Our research suggests that the fiscal risk premium and the bond offering premium (increased public financing requirements) embedded in South African government bonds are excessive. The curves are therefore steep when comparing the medium to long parts of the curve at the shorter end. This provides an opportunity to profit from high levels of return and, given the high shape of the curve, investors will reap the benefits of a steep rolldown over time.

Inflation-linked bonds are a niche in the sovereign bond market that is proving particularly attractive at the present time.

Inflation-linked bonds (ILBs or inflation linkers) are particularly attractive at the moment, for several reasons:

• Real returns above 4% for longer-term instruments are high by historical standards (above the 98th percentile) and are among the highest in the world.

• Total returns look very attractive compared to cash and fixed-face bonds, especially after adjusting for risk (no inflation or credit risk).

• Foreigners are not important players in this space.

• They provide valuable portfolio insurance in the seemingly unlikely scenario of a high inflation surge or even an anticipation of it (a scenario that would be very difficult for traditional cash and nominal fixed rate bonds) .

• ILBs play a valuable role in the portfolio because they bring a significant all-weather dimension to multi-asset and bond portfolios thanks to an adjustable base rate mechanism. During times of unexpected and high inflation, this is an invaluable counterbalance to many exposures in a portfolio. At a time when other floating alternatives are not attractive, short-term inflation linkers can be an effective choice of instrument.

While short-term ILBs are an attractive alternative to cash and floating rate credit today, we also find significant opportunities in long-term ILBs.

Long-term ILBs can be volatile given the relatively high duration characteristics (price is more sensitive to changes in returns), but at sufficiently high starting actual returns, they can start to compete with alternatives to equities, at low prices. much lower risk levels.

In the corresponding graph, we consider the expected range of results for the FINI 15 stock market index (a good indicator of South Africa’s interest rate sensitive stocks) and a long-term ILB maturing in 2050 on a horizon of one year. We consider four scenarios below. A bearish case, in which we assume a return to the (historic) lows reached in March / April 2020, a status quo scenario where there is no normalization of the rating, a bullish scenario where the rating reverts to 10 – annual average and, finally, a bullish scenario where the rating levels of the 90th percentile at 10 years are reached. Currently, the two investments have similar dividend / starting coupon yields of 5.0% and 4.3% respectively. Assuming the rating does not change and the capital grows with inflation (assumed to be 5%), we arrive at very similar status quo returns. However, given the range of downside and upside results, we see a very favorable asymmetry in the long-term ILB – especially given the risk-free nature of the investment.

The past year has seen a major recalibration of all fixed income opportunities. We have responded by reducing our liquidity and credit exposures and adding nominal and inflation-linked bonds, where short-term linkers play a valuable cash-like role and longer-term instruments offer similar expected returns. to those of stocks at a much lower risk.



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