The Northstar Income fund delivered a subdued return of 63bps for the quarter, however the 12 month return of 8.31% was robust in the context of an average peer return of 8.08%, a strategic benchmark return of 5.83% and infla..on 3.6%.

The strongest 12month contributors to outperformance of the strategic benchmark were fixed bonds 3.76% (vs the benchmark’s component 1.57%) and infla..on linked bonds contribu..ng 1.68% (vs the benchmark’s component 0.41%). Money market and floa..ng rate notes (combined average weight of 39%) contributed 3.26% vs 3.53% for the benchmark’s money market component at a weigh..ng of 50%. A small underweight in global bonds detracted 25bps from rela..ve returns, with the global bond index delivering a rand return of 4.26%, despite the weaker dollar over the period.

Set against a backdrop of low global infla..on, lower oil price, weak domes..c demand and a stable local currency, local infla..on moderated to 3.6% for the year. The three categories having the largest impact on lower infla..on were, Fuel (4.6% weigh..ng) which fell 6.5%, Housing (24.1% weigh..ng) rising only 3.1% and Communica..on (2.6% weigh..ng) which was flat for the year. Conversely the three categories which contributed the most to rising infla..on were, Insurance (10.1% weigh..ng) rising 6.7%, Electricity (weigh..ng of 3.8%) up 12.0% and Educa..on (3.1% weigh..ng) up 6.6%. Water and Food prices also accelerated 10.3% and 4.0% respec..vely.

On the back of very weak demand, infla..on is expected to remain well within the target range, and poten..ally close in on the 4.5% midpoint, despite the poten..al upside risks. These include nega..ve base effects on fuel and food, price shocks rela..ng to middleeast tensions (oil) and adverse weather condi..ons (food), a weaker Rand (as a result of the widely an..cipated Moody’s downgrade) and higher administered prices (electricity).

Growth remains constrained due to a mul..tude of factors which include; electricity supply constraints (poor SOE management), an overburdened consumer (lower wage increases, rising debt servicing costs and increasing taxes), poor poli..cal environment (corrup..on) and weak economic policy implementa..on (constrained new investment) resul..ng in persistently low growth. GDP is forecast to improve and rise to 1.2% in Q420 however will be dependent on Eskom and its ability to supply electricity and changes in the poli..cal climate, which impacts firms’ ability to produce and their willingness to expand capacity.

The fiscal risk remains elevated, however it is an..cipated there will be an improvement in the budget deficit forecast from 6.5% (presented in the 2019 MTBPS), to a more palatable sub 6% level in the 2020 Budget. However, the na..on’s debtGDP ra..o is unlikely to stabilise at a level lower than 72% (even accoun..ng for the full implementa..on of the proposed savings), which will very likely result in a downgrade by all the major credit ra..ng agencies. Most notably an an..cipated downgrade to junk status by Moody’s on the 27... March, and the subsequent exclusion from the WGBI (World Government Bond Index).

Notwithstanding the poten..al undervalua..on of the Rand on a purchasing power basis vs. the dollar, elevated fiscal risks, weak economic growth and further electricity load shedding poses a risk to the rand.

Given the poten..al for modest monetary easing, coupled with elevated nominal bond yields creates an opportunity to own fixed bonds. As such the Northstar Income fund has a modest exposure of 19% with a weighted average yield of 9.3 and modified dura..on of 7.4. Infla..on linked bonds yields have con..nued to rise during the course of 2019 as infla..on expecta..ons have lowered. However with real yields above 3% presented across the curve, the lower dated maturi..es look par..cularly a..rac..vely valued, especially if infla..on expecta..ons stabilise. The por..olio currently holds 35% in infla..on linked bonds with a weighted real yield of 4.0% and modified dura..on of 4.4. A..er the rand’s rally to below 14 to the dollar at yearend, the offshore component of the por..olio was li..ed to 12.5%, with 4% of that exposure to shortdated US infla..on linked bonds.

The por..olio is well diversified across different asset classes and issuers, and is posi..oned to take advantage of further local policy easing, any unforeseen increase in infla..on and deteriora..on in the rand. The focus remains on delivering a strong real return on an a..er cost basis, coupled with a very low risk of capital loss on a yeartoyear basis.