Global markets were characterised by a further easing of financial conditions. This was driven by increasingly dovish rhetoric from central bankers in the major economies. Lower inflation in major economies over the last couple of months has given cause for such rhetoric. This has provided a conducive environment for continued strong flow into emerging market assets and the rand has been no different, strengthening 1.4%, 0.8% and 3.5% against the US dollar, Euro and British pound respectively.

Yields on fixed assets have continued to fall across the world as financial conditions eased further and more term premia were removed from yield curves; US, UK and German 10-year government bonds all rallied between 18 and 20 basis points. Volatility implied and realised remained subdued, further driving demand for emerging market assets as investors continued their hunt for yield.

On the local front, inflation continued to decline and gives the South African Reserve Bank scope to cut interest rates at the next meeting in September. South Africa’s fiscal issues continue to deteriorate as the National Treasury recorded a record monthly deficit of 92b ZAR. This is a significant overshoot. If such underperformance relative to the budget projections is sustained South Africa’s annual fiscal deficit could breach the levels needed to maintain our current credit ratings. Other risks to the national purse emanate from the continued poor financial performance of the SOEs. Eskom has made an application for an extraordinary tariff increase circa 20% to plug their cash flow hole. The bailout of SAA is a further cause for fiscal concern.

Political noise going into the ANC elective conference at the end of the year will likely continue to increase. Over the last month this has taken the form of news campaigns by the various factions against the leaders of their opposition.

The above concerns have had little effect on the risk premium attached to investing in short-dated South Africa assets as easy offshore financing conditions have reduced risk premia significantly across the investment universe.

The Nedgroup Investments Flexible Income Fund gained 0.46 % in August, below the cash benchmark.

The domestic fixed income allocation performed well due to yield enhancement. Offshore fixed income assets underperformed as the rand strengthened against the developed market currencies. UK property detracted and preference shares were also slightly down. We continue to see UK property as cheap relative to fair value. The underlying assets are priced at crisis era discounts to gross asset value. The pound is also cheap relative to where we see fair value as the market continues to discount high levels of anxiety regarding Brexit.

We purchased offshore Steinhoff convertible bonds during the month after a selloff in the issuers equity forced these bonds to cheapen dramatically, to the point where the option adjusted credit spread presented a compelling investment opportunity. Credit spreads have tightened significantly over the last few months and most issuers no longer present compelling value relative to the credit and liquidity risk assumed. We have decided to increase our allocation to negotiable certificates of deposit issued by banks as their returns are now relatively attractive compared to corporate bonds and they have greater liquidity.
Duration has remained broadly unchanged at 0.14 years. The current duration is comparable to a money market fund as we do not want to take on interest rate risk with yields at current levels. We have continued to focus on maximising the yield of the fund by accumulating good quality floating rate assets at very attractive levels. The currency exposure is 7.2% at present, with an additional 3.6% allocated to European property assets. Our offshore bond holdings offer a very favourable return profile with acceptable risk.

The current market environment creates opportunities for yield enhancement and we will add to our holdings as we see value. We will continue to focus on maximising yield, while looking for strategic allocations to the various income asset classes in order to generate additional performance.

The weighted average yield of the Nedgroup Investments Flexible Income Fund is currently 8.6%.

Abax Investments

In December, South Africa avoided a downgrade to sub-investment grade as S&P left the foreign currency rating unchanged. The threat of a down grade has hung over SA markets throughout the year. The survival of Pravin Gordhan as the Minister of Finance was a critical element in maintaining the investment grade rating. National Treasury has been at the forefront of efforts to avert the downgrade as they understand the impact of rising debt costs on the budget. While there has been very little delivery on structural reform from government, National Treasury has delivered reasonably good budgets and this has been sufficient to placate the rating agencies. However, the situation remains precarious as S&P, Fitch and Moody's all have SA on "negative outlook".

Given the poor growth prospects, deteriorating debt metrics and continued political risk, it will be a challenge for SA to maintain its investment grade rating in 2017.The Fed hiked by 25 basis points at the December FOMC meeting in a well telegraphed move. US treasury yields continued to tick higher. In the final quarter of 2016 the 10-year US bond yield moved from 1.59% to 2.44%. This re-pricing was largely due to the election of Donald Trump. The market is now pricing in higher levels of nominal growth and larger budget deficits. The Fed hiked rates in December 2015 and then waited a full year to hike again. With inflation in the US moving higher, we would expect the hiking cycle to accelerate.

The Nedgroup Investments Flexible Income Fund gained 0.6% in December, outperforming the cash benchmark. Domestic assets drove performance with our yield enhancement strategies the primary driver. Domestic property added value while the offshore property stocks were a slight detractor as the rand strengthened during the month. Duration has remained broadly unchanged at 0.2 years. The current duration is similar to a money market fund as we do not want to take on interest rate risk with yields at current levels. The three-year swap is currently below 7.5%, which means it offers only a very slight pickup above three-month Jibar at7.36%. Unless one sees several rate cuts over the course of year, locking in rates at these levels does not represent value.

SA inflation will move lower incoming months due to base effects, but structural inflation in SA remains close to the 6% upper target. Economists have become optimist about the potential for rate cuts in 2017 but we believe that an extended period of flat rates is more likely. Inflation-linked bonds yields have moved up in recent months as demand has dried up. However, with yields just over 2% in the 10-year area they are still expensive relative to fair value and we continue to avoid exposure to the asset class.

Our currency exposure is currently 4% with an additional 2.8% allocated to European property assets. We maintained our position in offshore bonds as we believe they pose a very favourable return profile with acceptable risk. The weighted average yield of the Nedgroup Investments Flexible Income Fund is currently 8.8%.