The Absa Inflation Beater Fund invests in a strategic mix of domestic assets which is designed with the objective of generating a return of CPI plus 3% per annum over a rolling 3 year term, while trying to minimize the risk of losing money in any one year. Assets in the fund include: inflation-linked bonds, fixed-interest bonds, money market, equity and property. Assets selected for this fund are chosen carefully, based not only on return, but also with a view to minimize the potential downside risk of the portfolio.

The last 3 months have been characterized by a strong rebound in commodity prices which was led by a recovery in oil and base metal price. Consequently, strong commodity prices, weaker exchange rate of the rand against the majors and the suspension of the Mining Charter, led Resources stocks higher and they were amongst the best performers in the All Share index which subsequently contributed to equities being the best performing asset class in Q32017.
Over the past 12 months, the All Share index delivered 10.2% yoy with Industrials (13.3% yoy) and Resources (11.4%) stocks leading the broad index higher while Financials (7.6% yoy) lagged behind and performed in line with cash returns ( Stefi 7.6% yoy). The stock market performance was supported by a relatively stable exchange rate of the rand over the past year, strong commodity prices performance and relatively cheap equity valuations.

For the MPC, it was a quarter of surprises for markets. July's meeting saw the MPC cut rates by 25 basis points, on the back of improved inflation profile, in a move that was against consensus but this trend was surprisingly not followed on in the September MPC meeting citing increased risks to inflation from the currency into year end.
Also, 2Q2017 real GDP figures surprised on the upside with a rebound to 2.5% (QoQ SA annualized) thus breaking out of the 1Q2017 recession. Growth is expected to remain weak for the remainder of the year despite an improved global growth backdrop as domestic business and investor confidence remains low amidst political uncertainty.

The Inflation Beater Fund improved its 1-year performance from a sub-target return of 6.05% (CPI+3 target of 8.5%) in 2Q2017 to a matching return of 7.8% (CPI+3 target of 7.8%) in 3Q2017. The fund still lags behind its target return of CPI+3 in rolling 3-year but the turnaround strategy is yielding positive results, albeit in the short-term.
At the time of writing this report, the mix of assets in the Absa Inflation Beater Fund was:

Money market 2%
Inflation linked bonds 8%
Fixed & Floating interest rate bonds 83%
Domestic Equity 6%
Domestic Property 1%

Total 100.0%

The investment environment remains volatile. Our first aim is always to protect our clients' money, and to achieve a satisfactory return over a rolling three year period.

The Absa Absolute Fund invests in a strategic mix of assets which is designed with the objective of generating a return of CPI plus 4% per annum over a rolling 3 year term, while trying to minimize the risk of losing money in any one year. Assets in the fund include: inflation-linked bonds, fixed-interest bonds, money market, equity, property and offshore assets. Assets selected for this fund are chosen carefully, based not only on return, but also with a view to minimize the potential downside risk of the portfolio. The last 12 months have been characterized by low equity return environment and a very strong rand performance against the majors. The best asset class performance came from cash holdings at 7.7% yoy; while equity and property stocks returned 2% and 3% respectively; and bonds returned par with cash. Consequently, with the Absa Absolute Fund exposed to 30% in domestic equities and about 20% in offshore assets, the fund performance for the year was a sub-inflation return of 1.75%.

Abroad, US monetary policy remained on track for normalization as US economic data continued to reflect a modest recovery in real growth is still underway and the economy is operating at full employment. US inflation expectation remained anchored around the inflation target of 2% with 5y5y swap break-even inflation averaging 2.3% over the quarter. Consequently, the Fed showed its intent by hiking rates in June 2017 and further guided on reduction of the Fed balance sheet and continuation of rate hikes well into 2018 with a terminal fed fund rate guided at 1.9% - 2.6% by end of 2018. The ECB has signaled a possible beginning of tapering QE as deflation becomes reflation. According to their assessment, Euro area growth path is solid and broadbased. The pass-through of monetary policy measures has facilitated the deleveraging process and it should continue to support Eurozone domestic demand. The market response to the ECB’s comments was the steepening of the yield curve and strengthening of the euro in similar fashion to the Taper Tantrum in 2013.

Locally, Q22017 economic data releases showed a broad weakness of the economy that saw the country slip into recession in Q12017, and economic indicators painted a picture of further depression in the economy in Q22017. Furthermore, during the quarter under review, the sovereign rating was downgraded and political risk was elevated following comments from the Public Protectors about changing the mandate of the SARB. Inflation slipped further down with 5y break-even inflation averaging 5.6% in Q22017 (6.1% in Q12017), while real yields re-rated higher by 30bps and nominal yields remained relatively unchanged albeit closing the quarter weaker.

Estimate for world economic growth, according to the IMF World Economic Outlook, April 2017 report, is expected to rise from 3.1% in 2016 to 3.5% in 2017 and 3.6% in 2018. Stronger activity, expectations of more robust global demand, reduced deflationary pressures, and optimistic financial markets are all upside developments.

We remain cautious in the Absolute Fund, given the presence of increased political risk and slowdown in the economy. Our equity exposure continues to be focused on stocks that are trading at (or better than) fair value to the broad equity market, as well as stocks that exhibit above-average earnings growth and dividend yields; strong balance sheet and business proposition with diversification of earnings and visibility of cash flows.

At the time of writing this report, the mix of assets in the Absa Absolute Return Fund was:

Money market 2.0%
Inflation linked bonds 19.0%
Fixed interest bonds 9.8%
Floating rate instruments 16.2%
Equity 20.6%
Offshore investments 22.1%
Property 9.8%
Preference shares 0.5%
Total 100.0%

The investment environment remains stressed. Our first aim is always to protect our clients’ money, and to achieve a satisfactory return over rolling three years.

The All Bond Index increased by 2.5% over the 1st quarter. The respective total returns were: 1-3 year +2.6%, 3-7 year +3.4%, 7-12 year +2.6% and 12+ years 2.2%.

Inflation linked bonds lost 0.5% over the quarter, while cash returned +1.9%.

The first quarter saw investors attempt to gauge the size and shape of US fiscal policy under the new Trump administration. There were two FOMC meetings over the quarter with February seeing a 25bp hike to the policy rate. Fed Governor Yellen’s accompanying guidance was slightly more dovish than the market had been expecting and as a result US 10 year bond yields ended the quarter lower at 2.39% ytm.

The European Central Bank kept its policy rates unchanged at both of its monetary policy meetings. Oil ended the quarter largely unchanged at $52.90 per barrel.

In South Africa the bond market was poised to have an extremely strong quarter were it not for continued political risk surprises. The R186 yield had rallied from 8.95% in January to 8.25% an almost 5% capital gain. The surprise recall of the Finance Minister and his deputy caused mass panic for domestic investors as fears of a cabinet shuffle were all but confirmed. In an announcement made at midnight on the eve of 31st March the re-shuffle was announced. The market retraced 50% from its best levels ending up only 2.5%. Fears of ratings agencies downgrading the sovereign ratings were quickly being factored in.

The March MPC occurred just prior to the re-shuffle announcement, the tone had changed in anticipation already with a more hawkish outlook based on the political uncertainties and the price volatility that would result. The inflation outlook had improved in the SARB forecast however risks were seen to the up-side.

The FRA market which had at one point been pricing in almost two interest rate cuts this year had returned to pricing the next move in rates higher by the end of the quarter. We expect monetary policy rates to remain flat for the year ahead.

Appetite for emerging market risk has increased as the markets expectations of US policy change somewhat. Foreign investors bought R19 million of bonds in March.

The Bond fund maintained a moderately defensive position over the quarter and will continue to adjust its duration and exposure as required in the heightened risk environment.

The investment environment remains extremely challenging. Despite a challenging year for the equity and bond markets, the Absa Inflation Beater Fund has returned 5.6% over the past year. The Fund returned 6.9% p.a. over the past 5 years, which is 1.3% above CPI for the 5 year period.

Since the Great Financial Crisis of 2008, worldwide governments and central banks have created a generally positive backdrop for risky assets by means of accommodative monetary policy. We have seen interest rates starting to rise in the USA, but not yet in other major Developed Economies. A major reversal of ultra-low interest rates could have a devastating effect on global financial markets.

Estimates for world economic growth have been revised modestly higher, and there is some optimism that Trump may be able to encourage USA economic growth through tax cuts, removal of certain bureaucratic impedances to growth, as well as infrastructural spending. However, the level of the USA fiscal deficit may limit the size of economic stimulus. In addition, there are threats in the form of anti-globalization policies and the consequences of BREXIT for economic growth are causes for concern. The risk of Chinese economic growth slowing as well as high Chinese credit levels also need to be considered carefully. In many parts of the world we are seeing rising social tensions and a shift to more extreme political views, all of which could impact on global and South African growth prospects.

There are various country-specific risks being faced by South Africa as a result of trade and budget deficits, poor economic growth and general political uncertainty. The South African equity market has basically moved sideways since the middle of 2014. Reported company earnings are expected to recover to some extent this year, bringing the forward price earnings ratio of the stock market back to close to reasonable valuation levels, though still not cheap levels compared to its own history.

In terms of equity exposures, we continue to focus on companies that are trading at parity (or at a discount) with the market at large, yet have higher earnings and dividend yields, strong business franchises and balance sheets, and better visibility of cash flow. The Absa Inflation Beater Fund continues to be positioned so as to minimize the risk of capital loss, whilst targeting a return in excess of inflation, by holding a diversified portfolio of assets including an exposure to equities, though this is limited to 20% of the total fund.