Malcolm is a portfolio manager in the South African Rates team, with responsibility for a range of fixed income portfolios, including the Flexible Bond, Dynamic Bond and Diversified Income strategies as well as the Fixed Income hedge fund. Prior to joining the firm in 2001, he worked for African Harvest Fund Managers and Old Mutual Asset Managers, as both a fixed interest trader and portfolio manager. Malcolm graduated from Rhodes University with a Bachelor of Commerce degree in Accounting, Business Administration and Commercial Law.
Peter is a Co-Head of SA & Africa Fixed Income and is a portfolio manager in the South African Rates team at Ninety One. He has responsibility for a range of fixed income portfolios, including the Flexible Bond and Diversified Income strategies, complementing the team with his global macro experience. Prior to joining the firm, he spent eight years as an interest rate derivative trader at Goldman Sachs in London, with responsibility for managing European swap flow and prop books. Peter holds a Bachelor of Commerce (Hons) from the University of Cape Town, and a Master of Science degree in Finance from the London Business School. He is also a Chartered Accountant (SA) and a CFA Charterholder.
Discovery Diversified Income comment - Sep 15
Portfolio review Against a backdrop of elevated volatility, local yield-oriented assets exhibited resilience as they produced positive returns over the quarter. Similar to the preceding period, global markets were skittish as they were unnerved by the deteriorating growth outlook. Also, and perhaps more central to the pick-up in volatility, was heightened uncertainty within emerging markets, particularly concerning China. Economic data releases from China repeatedly undershot expectations, suggesting a sharper-than-expected slowdown. To this end, the People’s Bank of China (PBoC) employed an array of stimulatory measures to fend off economic headwinds, including the devaluation of the renminbi. This precipitated the currency’s largest depreciation in two decades, spiking market volatility and exacerbating China growth concerns. Invariably, these developments had widespread ramifications, including a commodity price rout and a deterioration in sentiment towards emerging markets. That said, developed markets were not shielded from the fallout. Besides the reaction from global markets, a larger question mark now hung over the outcome from the Federal Open Market Committee (FOMC) meeting in September - the prospect of a historic US interest rate hike was arguably as strong as it had ever been leading up to the meeting. However, the US Federal Reserve (Fed) stood firm, keeping rates unchanged for the time being. A resilient US economy - albeit with signs of recent weakness - did not appear enough to prompt the central bank to look through a brittle global economy and low inflation. Indeed, Fed Chair Janet Yellen warned the recent global weakness, fuelled most prominently by the slowdown in China, may restrain US economic activity somewhat. Subsequent to this, the market repriced Fed rate hikes to take place in 2016.
On the domestic front, the pre-emptive 25 basis point rate hike by the South African Reserve Bank (SARB) in July allowed the central bank room to manoeuvre ahead of the next monetary policy committee (MPC) meeting. To that effect, Governor Lesetja Kganyago alluded to a more dovish stance in August, highlighting the moderate nature of the planned hiking cycle. Weak local economic growth, illustrated by disappointing second-quarter economic growth (GDP contracted by an annualised rate of 1.3% over the period), also tempered the prospect of a rate hike. Thus, as expected, the central bank kept rates on hold in September - improvements in the inflation outlook due to falling oil prices and moderating core inflation were key to the decision. The impact of these two factors was also apparent in headline inflation. After edging higher in the initial two months of the review period, consumer inflation diverged from its upward trend - following five consecutive months of increases, including the shift from 4.6% in May to 5.0% in July on a year-on-year basis, inflation slowed to 4.6% in August. The recent decline was largely attributed to a drop in petrol prices. Following on from the monetary policy decision in September, Governor Kganyago confirmed the SARB would remain on a gradual normalisation path and would not hesitate to act should the inflation outlook deteriorate. Going forward, the key swing factor will likely be the strength of the rand, or lack thereof. On this note, the local unit would have done little to appease the SARB, as the emerging market currency rout showed no signs of abating. Fears over the decelerating Chinese economy and the heightening prospect of a Fed rate hike conspired to sour sentiment towards emerging market currencies, particularly those of commodity-exporting nations. This backdrop saw the rand breach the R14.00 level against the US dollar on several occasions, reaching an all-time record high of R14.06 in the process before recovering somewhat towards quarter-end. For the quarter, the portfolio outperformed the benchmark. Our foreign currency exposure contributed positively to performance as the rand retained its weakening bias against the major currencies. On top of providing downside protection, our position in cash added to returns, while our shorter-dated bond holdings also enhanced gains. Our positions in longer-dated bonds and preference shares delivered muted gains and dragged on overall performance.
Portfolio activity We slightly increased our duration position into weakness as nominal bonds sold off towards quarter-end, but still remain defensively positioned. Although we believe corporate bonds are still fairly priced and offer a reasonable yield premium over sovereign bonds, we remain wary of certain sectors (namely parastatals, resources and retailers) and have trimmed our allocation to these areas where liquidity has allowed. We reduced our exposure to inflation-linked bonds by switching into nominal bonds as we believe they remain relatively expensive, and expect some relative correction between these two asset classes. Although we remain constructive on the US dollar on a longer-term basis, we have reduced our foreign exchange position as some of the recent US dollar strength could unwind in the short term.
Portfolio positioning We continue to maintain our cautious positioning given the uncertain local and global outlook. On the global front, China is continuing to show signs of fatigue and this is particularly concerning for emerging markets and commodity-producing economies, including South Africa. US monetary policy developments should continue to have a bearing on markets. A prospective Fed rate hike could result in further emerging market currency weakness. We will continue to observe developments and central bank activity, as emerging markets, particularly their respective currencies, remain sensitive to global economic factors. Locally, economic momentum has been tepid and the growth outlook remains weak at best. This backdrop will likely place pressure on the government’s fiscal position, possibly undermining sentiment towards the local bond market, while also affecting the views of rating agencies. Although inflation expectations have moderated somewhat recently, risks are still stacked on the upside (including a persistently weak rand) and could lead the SARB to shift to a tightening bias. We remain defensively positioned ahead of the medium-term budget policy statement (MTBPS). In terms of curve positioning, we favour shorter-term bonds over their longer-term counterparts. We are underweight longer-end bonds as we view these as more susceptible to budget surprises or possible sovereign credit rating downgrades. In our view, shorter-term bonds are more attractively valued as the market is currently pricing in 100 basis points of rate hikes over the next 12 months, which is too excessive in our opinion. We believe the combination of a muted exchange rate pass-through to inflation and tepid economic growth will allow the SARB to travel on a much shallower rate hiking path. We are underweight listed property. In our view, the asset has become progressively more expensive relative to nominal bonds; hence we have limited our exposure to the sector. We have maintained our overweight cash position. Although cash currently offers a lower yield than other fixed income assets, we believe its defensive characteristics are appealing in a volatile environment. Furthermore, cash offers us optionality should attractive opportunities arise across the fixed income spectrum in the upcoming months.