Global bond yields continued the strong downward trend that commenced in the latter part of 2018. The combination of strong disinfl ationary forces, heightened fears of a global recession and broad-based monetary policy easing is mainly to blame. The yield of the 10-year US Treasury bond dropped a very signifi cant 56 basis points (bps) to 1.47% from the end of June to the fi rst week of September – the lowest level in three years. Elsewhere, German Bund yields were forced deeper into negative territory, with the entire yield curve trading at sub-zero levels.

Local market activity during the period under review is best described as a rollercoaster ride. The 56bp intra-quarter trading range of the benchmark 10-year RSA government bond (R2030) best illustrates the extent of the market volatility. After reaching a best level of 8.6% in mid-July, the R2030 yield retraced sharply to 9.2%. This was followed by a signifi cant bull rally of 35bps before another retracement forced the market to close weaker at 9.0%. This was 20bps higher than the closing level at the end of the second quarter.

The nominal bond yield curve slope steepened during this period. The combination of the July repo rate reduction, a benign infl ation backdrop and rising concern about the worsening fi scal backdrop caused longer-dated bond yields to increase relative to shorter-dated bond yields. As a result, the JSE All Bond Index (ALBI) delivered a 0.7% return over this period, well short of the cash return of 1.6%.

The fund underperformed the benchmark by 0.9% on a net-of-fee basis for the 12-month period ending September 2019. This was mainly due to the more conservative positioning of the fund relative to the benchmark, specifi cally the underweight modifi ed duration position during the period under review. This negative contribution was partly offset by the accrual earned from the higher yielding non-government bond holding in the fund.

The fund is defensively positioned with an underweight modifi ed duration tilt of 0.3 relative to the ALBI modifi ed duration of 7.0. This is the result of a smaller holding of nominal bonds with a term to maturity of 25 years plus relative to the benchmark. The underweight position at the back end of the yield curve is offset by a small cash holding and an overweight exposure to short- and medium-dated non-government nominal bonds. This position refl ects a balance between minimising capital loss in the case of rising longer-dated bond yields, and not foregoing all of the accrual offered by the steeply sloped yield curve. The fund will benefi t most in the case of bearish yield curve steepening, that is when yields of longer-dated bonds rise by more than those of shorter-dated bonds. It should also benefi t in the case of a repo rate reduction, but specifi cally when short- and medium-dated bond yields decrease by more than those of longer-dated bonds in response to such a monetary policy change.

Our main concern regarding the bond market remains the strong link between lacklustre economic growth and the lack of fiscal consolidation. More specifi cally, this points to the rising debt burden of the state, which arises as a consequence of the lack of fi scal consolidation. This continues to threaten the country’s sovereign risk profi le and places pressure on domestic funding costs. The risk of a failed economic recovery has certainly not dissipated; with this fi rmly supported by disappointing fi rst quarter GDP data. This makes us question the quality of tax revenue collections, and consequently the state of health of the tax base, which in turn keeps the risk of a budget defi cit overrun at elevated levels. The fi nancial burden of poorly managed SOEs on state fi nances has reached a point where the delivery of a credible national budget is nearly impossible in the absence of a substantial remedial action for the unfolding fi nancial disaster. The proverbial chickens, mainly in the form of Eskom, have come home to roost and this requires more than the usual liquidity provision. Addressing solvency is an entirely different matter, requiring more than simply kicking the can down the road via more liquidity bail-outs.

On the monetary policy front, we maintain our view, following the Monetary Policy Committee (MPC)’s decision to keep the repo rate stable in May 2019, that the central bank will remain hostage to the opposing forces of a lacklustre economic growth outlook and limited upside risks to infl ation in light of the strong disinfl ationary environment. This is best refl ected by the recent split decision by the MPC members, with two members voting for a rate cut. Although this implies a higher probability of a rate cut in the near term, we are sticking to a stable policy path for now, but acknowledging that the risk is to the downside in light of weak economic growth and strong disinflationary forces.

With the above in mind, we continue to endeavour to strike a balance between avoiding capital loss in the case of a market sell-off and losing out on the accrual offered by a steeply sloped yield curve. We have also considered the fact that longdated nominal bonds are currently trading at an attractive real yield of around 4%. So, while our broad interest rate investment strategy remains defensive, the modifi ed duration variance of -0.2 is some way off the maximum allowed position of -1.0. This acknowledges reasonable valuation, which partly offsets the relatively poor investment theme.

The fund underperformed the benchmark by 1.1% on a net of fee basis for the 12-month period ending June 2019. This was mainly due to the more conservative positioning of the fund relative to the benchmark, specifi cally the underweight modifi ed duration position during the period under review. This negative contribution was partly offset by the accrual earned from the higher yielding non-government bond holding in the fund.

The fund is defensively positioned, with an underweight modifi ed duration tilt of 0.2 relative to the All Bond Index modifi ed duration of 7.1. This is the result of a smaller holding of nominal bonds with a term to maturity of 25 years and longer relative to the benchmark. The underweight position at the back end of the yield curve is offset by a small cash holding and a signifi cant overweight to short- and medium-dated nongovernment nominal bonds.