Nedgroup Inv Flexible Income comment - Sep 08 - Fund Manager Comment29 Oct 2008
A benign view on future inflation has lead to the market pricing in rate cuts totalling almost 300 basis points (bps) over the next 18-months, starting in early 2009.
CPI and CPIX rose to 13.7% and 13.6%, up from 13.4% and 13% respectively, higher than market expectations. The market has shifted from holding a very negative view on inflation to one that is very positive. Some caution is warranted as although the re-weighting and rebasing of inflation will result in a technical drop, the outcome of inflation in a year's time is dependant on actual price increases. PPI rose to a 6-year high of 19.1% driven largely by increases in basic metals and electricity tariffs.
The market is aggressively pricing in 200 bps worth of rate cuts over the next year and almost 300 bps worth of cuts over the cycle.
Despite the turmoil in global markets, and a weakening of the rand, bond yields fell around 200 bps over the quarter as the market looked to price in a very positive inflation outlook. Much of the ALBI performance was achieved in July, where the index delivered a return of 8,5%, its greatest monthly gain in 10 years. Bonds consolidated their gains in August and September, continuing to outperform cash as yields ticked down further.
Credit markets have come under extreme pressure, placing huge strain on companies in both developed and emerging markets. With very little borrowing being able to take place, the downturn in financial markets is now been transmitted into the broader economy. This impending slowdown is likely to reduce inflation, and cause international rates to remain at low levels for an extended period of time.
With bond yields falling, the ALBI outperformed cash by 977 bps for the quarter. With yields falling across the curve, the long end benefited due to its higher duration. The 12+ year index returned 19,9%, outperforming the overall ALBI's return of 12,6%. Bond yields have been extremely volatile over the quarter as the market is caught between growth and inflationary concerns. The US 10-year yield fell 15 bps to 3,8%; euro area bonds fell 64 bps to 4.0%, while UK bonds fell 71 bps to 4,4%.
South Africa's country risk premium, the yield spread of South Africa's dollar-denominated bonds over US treasuries, increased dramatically due to the credit crisis, as well as the increased political risk specific to South Africa. The country risk premium ended the quarter 142 bps higher at 4,0%.
The property sector had a strong quarter, gaining 23% as yields fell in line with the fall in bond yields. The prospect of lower funding rates has helped the market recover some of the losses it had experienced over the course of the year. However, costs in the sector remain high, and higher credit spreads mean that funding is unlikely to become cheap. The sector will continue to face a difficult environment going forward and we have decided to maintain a zero allocation to the sector, but will continue to monitor the asset class for opportunities in stocks with attractive yields.
The US dollar rebounded strongly in the third quarter, gaining against all currencies during a period of risk aversion. The rand lost around 5,3% against the USD, while gaining 5,3% and 5,5% against the euro and sterling respectively. The fund maintained an offshore exposure of 15%, which added to the fund performance over the month. An exposure to AUD was maintained, with the exposure equally weighted between euro, GBP and AUD. The options on the GBP and euro exposures enabled the fund to take advantage of the dollar strength. While the rand had a relatively stable quarter on a trade-weighted basis considering the overall strength of the USD, there continues to be significant risk to the currency due to the large current account deficit and growing risk aversion.
Relative to US bonds, SA bonds are currently discounting domestic inflation of 3% at the short and medium ends of the curve. Implied inflation at the long end is around 1% to 2%. The level of implied inflation discounted in local bonds has fallen dramatically, as local yields have shifted down, while international real yields and the country risk premium have moved higher. While the inflation outlook is somewhat improved due to falling oil and commodity prices, the outlook 2009 remains uncertain. The local bond market is failing to reflect the higher level of South African country risk that is being priced into global markets. As long as this remains the case, there is a very significant upside risk to bond yields.
International money markets are in a state of uncertainty, as policy makers globally look to balance the poor growth outlook with high levels of inflation. With the US FED having delivered 325 bps worth of cuts so far, the market is now pricing in flat rates over the course of 2009. Rates in the UK and euro area are now pricing in flat to lower rates going forward into 2009. Given the extent to which inflation has increased across the world, money market rates remain low and the risk to short rates remains to the upside.
The volatility in the rand continued over the month and highlights the vulnerability of the currency to the high current account deficit and dependence on commodity prices and capital flows.
The fund had around 50% in the one-year area and 20% in the two-year area as the market had priced in aggressive rate hikes, which were not warranted given the state of the economy. With one-year rates falling over 200 bps from their peak, the allocation to long assets were unwound and shifted back into Floating Rates. The extent to which rate cuts are being priced into the market is at odds with the inflation outlook for 2009, where inflation is unlikely to fall below the 6% upper band of the inflation target. With little value along the curve, we will continue to focus on enhancing yield at the short end.
The spread between the bonds and swaps has narrowed, but remains at wide levels. We have continued to utilise this spread when adding exposure in the 1-3 year area of the curve.
Over the quarter, yields fell as the market began pricing aggressive rate cuts over the next year. With yields in the 1-3 year area having fallen significantly, we are now seeing greater value in the 3-month space. Given the inflation risks going forward, we would look to move into longer assets only once we see significant value.
Nedgroup Inv Flexible Income comment - Jun 08 - Fund Manager Comment25 Aug 2008
At the start of the month, the market was fully pricing in a 1% interest rate hike with another 0.5% expected in the future. One-year money market paper moved up and assets could be invested earning a yield of 14%.
The latest inflation releases came in above market expectations; PPI figures came in worse than expected; private sector credit growth marginally up, while money supply was very similar to the previous month; and the current account deficit widened to 9% of GDP - these factors continue to highlight a deteriorating inflation outlook, which has left rates vulnerable to upward pressure. Some assets were switched into the 1-year area earlier in the month, locking in higher yields. The remainder of the portfolio is invested in JIBAR-linked exposure and some inflation-linked assets. Credit exposure remains very conservative.
The bond market experienced a harsh re-pricing in the second quarter, with yields driven higher due to a deteriorated inflation outlook, as well as a significant rise in bond yields across the world. The yield curve shifted up around 200 basis points in the short end of the curve, with bonds from 5 years out shifting up around 130-160 basis points. With bond yields rising, the ALBI underperformed cash by 755 basis points for the quarter. As yields shifted up, the 12+ year index delivered the worst performance due to its high duration. The 12+ year index returned -8,5%, underperforming the overall ALBI's return of -4,9%.
Relative to US bonds, SA bonds are currently discounting domestic inflation of just under 10% at the short end of the curve, and around6% in the medium area of the curve. Implied inflation at the long end has moved up to around 4,5% to 5%, which is a significant re-pricing from the 3% level of implied inflation that prevailed earlier in the year. The value in SA bonds has risen due to the rise in local yields, although the rise in international yields and the country risk premium has offset some of this increase in value. Despite the greater value in bonds, the outlook for inflation continued to deteriorate over the quarter and South African yields are still not compelling at theses levels.
With the market seeing the 25 basis point cut in US rates as the last in the cycle, bond yields began to move up due to inflationary concerns. The US 10-year yield rose 53 basis points to end the quarter at 4.0%. Euro area bonds rose 71 basis points to 4,6%, while UK bonds moved up 76 basis points to 5,1%.
The property sector had an extremely poor quarter as interest rate hikes continued to put the industry under pressure by drive up funding costs. The property sector lost almost 20 percent for the quarter. Higher cap rates, rising building costs and the prospect of further rate hikes this year are severely impacting sentiment and yields in the sector. Given the rapid fall in valuations, much of the anticipated corporate action has been put on hold. The deteriorating outlook for the sector led us to reduce the allocation over the course of the year, with the allocation being sold out completely in May.
The rand had a very strong start to the second quarter, but the fundamental problem of financing the current account deficit eventually weighed on the currency and it ended the quarter only slightly stronger. The trade-weighted exchange rate has still weakened 17,4% since the beginning of the year, which is likely to exert further upward pressure on inflation. To date the fund has benefited from having Euro and GBP exposure in the offshore allocation. Given the large outperformance of these currencies against the dollar, and the potential for some dollar strength going forward, we have adjusted the allocation to an equally weighted basket of USD, Euro and GBP. We also have options on the GBP and Euro exposures, which enable the fund to take advantage of any further dollar strength. We have maintained the overall offshore allocation at around 15%.
The downward pressure on global money market rates totally reversed over the quarter due to widespread inflationary pressure. With the US FED having delivered 325 basis points worth of cuts so far, the market is now pricing in rate hikes. Rates in the UK and EURO area are also predicted to rise. In response to rising inflation, many central banks, including the SARB, have been forced to continue hiking rates beyond market expectations.
The fund duration was increased over the quarter as rates moved up significantly. Prior to the June MPC meeting, there was much talk from Tito Mboweni, which led the market to believe that a rate hike of 150-200 basis points was plausible. This caused the yield curve to shift up dramatically, with 1-year rates rising above 14%. Given the impact of the upward interest rate cycle on the consumer and the economy, we did not feel that aggressive moves were warranted, and looked for the reserve bank to continue hiking in 50 basis point increments. We therefore saw much value in the higher level of 1-year rates and invested50% of the fund's assets in this area.
The spread between the bonds and swaps has remained at wide levels, and we have continued to utilise this spread when adding exposure in the 1-3 year area of the curve. We have locked in some fixed rates in the 2-year area as we saw value.
Over the quarter, the yields moved up significantly as the Reserve Bank hiked rates by 50 basis points at both the April and June MPC meetings. The money market is now pricing in a further 80 basis points of rate hikes over the coming Reserve Bank meetings. We have maintained a very low portfolio duration to date, looking to maximise yield and provide protection in the case of rising interest rates. With short-term yields having moved up significantly, we are seeing greater value in fixed assets, and will look to add further exposure over time.
Nedgroup Inv Flexible Income comment - Mar 08 - Fund Manager Comment04 Jun 2008
The reserve bank left the repo rate unchanged at 11% at the January MPC meeting, a move that was largely priced in by the market.
Over the month, CPI and CPIX accelerated to 9.8% and 9.4% respectively,up from 9.3% and 8.8% in January. Inflation remains under pressure from increases in food and transport costs, running at 14.3% and 13.2% respectively, with running costs up to 23.8% on a year on year basis.
The bond market had a very poor first quarter as yields shifted up due to pressure from rising inflation, as well as a rising country risk premium. The yield curve shifted up around 50 basis points in the medium area of the curve, while the long was affected to a greater extent as yields rose 80-100 basis points.
The fund is structured with a short duration, with the largest allocation to Money Market assets linked to the 3-month JIBAR. Given the deteriorated inflation outlook, and the potential for further upward pressure on rates over the course of the year, we see significant value at the short end of the curve. The fund has benefited from holding inflation-linked bonds in an environment of rising inflation. We have sold out this allocation over the quarter, with the proceeds being invested in money market assets at the higher level of yields.
The property sector had a poor quarter, losing over 10% as the market re-rated and yields move upwards. The market continues to be weighed down by the prospect of further interest rate hikes. We maintained a low allocation, continuing to look for property assets with growing yields and the potential for capital gains through corporate action.
The international exposure was maintained at the higher level of 15%, and has been a driver of fund performance as the rand has depreciated.
The spread between the bonds and swaps has remained at wide levels, and we have continued to utilise this spread when adding exposure in the 1-3 year area of the curve. We have looked to add exposure in the 2-year area through the use of swaptions. The fund therefore has option of locking into 2-year assets if rates fall, while maintaining exposure to JIBAR-linked assets in the case of rising rates.
Over the quarter, the yield on money market assets ticked up as the inflation outlook continued to deteriorate. The money market has priced in a 50% chance of another hike in April, with rates falling from early next year. We have maintained a low portfolio duration, looking to maximise yield and provide protection in the case of rising interest rates. With short-term yields having moved up significantly, we have added some exposure through options, and will look to add further exposure in the 1-3 year area when we see significant value.
Nedgroup Inv Flexible Income comment - Dec 07 - Fund Manager Comment17 Mar 2008
This month we maintained a short duration in order to maximise yield and protect capital. As rates have moved up, we are looking for opportunities to lock in yields. The money market allocation was the preferred asset class for maximum yield. The offshore allocation was maintained at 15%, with exposure to the euro and sterling. The exposure to interest rate swaps was kept at 14% over the month as rates were stable.
Exposure to inflation-linked bonds was maintained at the lower level of 3%. With the fund having benefited from falling real yields, we now see better value in the money market.
Going forward, we will look to maximise yield on the fund, and look for assets with potential for capital gains.