fundfocus Allan Gray
OUTLOOK
Do bonds offer opportunity in a post-Covid-19 world?
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Investors must think about what the world will look like when the pandemic has passed, and which asset classes offer opportunity. How do bonds fit into the mix? he Covid-19 pandemic has seen monumental swings risk inherent in a fixed-rate instrument. Bond prices have an in investor sentiment. While it cannot be denied that inverse relationship with interest rates or yields; if yields go up, there are many investment risks that may persist after prices go down and vice versa.” the pandemic, there is also great value to be found. She adds that at Allan Gray, bond fund managers try to Are bonds attractive enough to offer investors a haven from anticipate major trends in the investing environment, with an coronavirus fears, and if so, where are the opportunities? emphasis on economic health and GDP growth. “South African bonds are pricing in enough bad news to be “This is important because it has implications for the attractive, offering interest rates more than double the rate of ability of debt issuers to service their debt. Although not inflation,” says Londa Nxumalo, portfolio manager at Allan Gray. experts in macroeconomic forecasting, we assess the Before jumping in and investing, Nxumalo says that it likely direction of inflation as this helps us to determine, for is useful to understand the context in which bonds have example, if nominal bonds or inflation-linked bonds offer performed over the last year. better value.” “Most of bonds’ poor “Most of bonds’ poor performance over the last year Also important are bond market dynamics, in terms performance over the last can be traced to March 2020: Bonds sold off massively, of supply from issuers (the government and corporates) year can be traced to March 2020: with yields on the long end touching 13.7% at one point. Bonds sold off massively, with yields and demand from buyers, such as institutional and on the long end touching This was off the back of intense foreigner selling due to retail investors, and foreigners. Increased supply in the coronavirus-related risk aversion and leading up to the absence of commensurate demand results in higher Moody’s downgrade.” yields and lower prices. She adds that the sell-off was further exacerbated “We also consider relative opportunities – such as by local fund managers being forced to sell bonds to credit spreads (the margin or relative return above the riskat one point.” meet margin calls on bond futures. Yields subsequently free rate that investors demand from different issuers) stabilised when the South African Reserve Bank stepped in and and the yield curve (which is essentially the plotting of the started purchasing bonds to restore order in the bond market. interest rates the government pays at different points in time).” “Nonetheless, bond yields have remained between 100 basis The Allan Gray Bond Fund has delivered returns above points (bps) to 200 bps wider than in February.” inflation, as well as the All Bond Index (ALBI), over the But investors have reason to be concerned, as SA’s long term. Its current positioning attempts to strike a fundamentals have continued to deteriorate. balance between attractive real yields and prevailing “The government deficit, already projected to be the macroeconomic and fiscal risks. highest in decades, is likely to balloon even more due “We have been cautiously increasing duration to take to Covid-19. Government debt has grown faster than advantage of the high yields. We have been reducing nominal GDP since 2010 – implying that debt was used to credit exposure due to unattractive credit spreads given fund consumption, rather than investment.” elevated risks. Most of the fund is invested in government But has the bad news that bonds have priced in been bonds, with conservative credit exposures.” Londa Nxumalo Portfolio manager overdone? But, why the exposure to government bonds given the at Allan Gray “SA’s credit spread relative to the US is a full standard burgeoning fiscal risks? deviation above its long-term mean. The spread between the She explains that the anticipated deluge of supply will put ten-year and three-year government bonds is as high as it was in upward pressure on bond yields; more debt also results in the 1980s – when the country was an isolated pariah state. SA’s higher credit risk and higher bond yields due to a larger risk real yields are the highest among emerging markets.” premium. However, the sovereign is still the best credit in the country because the government can print money. “Furthermore, SA bonds’ attractiveness relative to Balancing risk and seeing above-inflation returns emerging market peers, together with local multi-asset Nxumalo says that as a bond investor, you should look to achieve investors’ interest at these levels, act as a counterforce to an a decent absolute return in the current environment. Funds with unchecked spiral in yields,” says Nxumalo. an approach that is uncomplicated and simple, and that seek The fund currently has a running yield similar to the ALBI, to generate above-inflation returns without taking on too much but with a lower duration – partially in recognition of the fiscal risk, can be used to create diversity in your portfolio. risks abounding, especially considering the current market “There are three key risks that need to be balanced: liquidity, uncertainty. ■ credit and duration, the latter of which refers to the interest rate
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finweek 25 June 2020
www.fin24.com/finweek
