The third quarter of 2019 was characterised by continued market volatility and further declines in global bond yields. Negative interest rates in Japan and the Eurozone, and mounting expectations that the US Federal Reserve will cut interest rates several more times in the months ahead, have expanded the pool of bonds with sub-zero yields to more than $15 trillion – or around 25% of the global bond market. In Germany, yields are negative all the way from cash deposits to 30 year bonds. In Switzerland negative yields extend all the way out to 50 year bonds. The current 6% income yield of the Essential Income Fund is attractive against this backdrop of low yields globally.

The high yield of the portfolio can largely be explained by a domestic market which has gone sideways for the past 5 years, whilst the dividends from high quality SA businesses have steadily increased. This has resulted in a significant increase in the dividend yields (decrease in PE ratios) of listed property and equities as a low growth environment has been increasingly “priced in”.

To ensure dividend and capital growth from the SA equities in our portfolios (an approximate 45% weighting), we have restricted our investable universe to market leaders in industries such as food, healthcare and value retailing. Based on our experience, investing exclusively in quality, non-cyclical franchises is the best way to ensure growth in a struggling economy – high class operators tend to take market share when times are tough, and non-cyclical industries command the greatest pricing power. From a property perspective (an approximate 30% weighting), we have also been extremely selective by only investing in REITs with first-class property portfolios, reasonable debt levels and good corporate governance.

With regard to the fund’s bond exposure, longer dated SA bond yields have also moved higher as a result of a looming credit rating downgrade to “junk” status by Moody’s. The current yield of the SA 15 year government bond is approximately 9.6% - well above the current inflation rate of 4.3% - which suggests the downgrade is now reflected in the price. The fund has an approximate 24% exposure to this particular bond.

In summary, the improved valuations of SA asset classes allows investors in the Essential Income Fund to draw a high, inflation hedged income without eroding capital – the key to a more predictable retirement outcome.