With inflation persisting at multi-decade highs during the fourth quarter of 2021 in both developed and emerging market economies, central banks had very little choice but to start singing from their respective monetary tightening hymnbooks. Although the tightening crescendo is yet to be reached, the US Federal Reserve has taken to doubling the pace of tapering to $30bn per month, which puts it on course to end its $120bn monthly asset purchases by the end of the first quarter in 2022. Domestically, the South African Reserve Bank (SARB)’s Monetary Policy Committee (MPC) has hiked the repo rate by 25 basis points for the first time since 2018 after having cut the rate by a cumulative 300 basis points since the beginning of the Covid-19 pandemic. The decision to increase the repo rate was split 3-2 on the five-person MPC, with the SARB citing concerns around short-term externally driven inflationary pressure contributing to the decision to gradually increase short-term rates.

Fitch Ratings became the first of the major rating agencies to upgrade their outlook on South Africa during the past quarter. Although SA’s foreign and local currency rating remain three notches below investment grade at BB-, the outlook has been revised to stable from negative. The rating agency cited a more robust economic recovery as well as strong fiscal performance as key drivers behind the outlook change. The news triggered a local bond market rally and helped bonds end the year off on a strong note, after having endured a somewhat volatile quarter characterised by contagion from Turkey’s central bank decision to cut interest rates despite sky-high inflation, and the emergence of the Omicron Covid-19 variant, which triggered a flurry of travel restrictions aimed at Southern Africa. Various forms of lockdown, predominantly in the developed world, continue to threaten the global GDP recovery.

The fund returned 8.3% for the 12-month period ending 31 December 2021, underperforming the benchmark by 0.1%. Underperformance was primarily due to the fund’s large underweight position in the very long end area (+20 years) of the nominal yield curve given the yield curve bull flattening over the period under review.

The fund continued to maintain minimal exposure to cash given the elevated opportunity costs of cash relative to higher-yielding nominal bonds. The fund rolled up the yield curve into bouts of bear steepening over the quarter. The initial roll-up occurred on the back of Turkey-induced contagion risk. The fund sold nominal bonds in the 7- to 12-year area of the yield curve and used the proceeds to purchase bonds in the +12-year area of the yield curve. A second bout of risk aversion occurred as a result of the discovery of the Omicron Covid-19 variant. The fund once again used yield curve steepness to switch from bonds in the 7- to 12-year area of the yield curve to bonds in the +12-year area of the nominal bond curve, thus taking advantage of better buying levels.

We will continue with this strategy of active positioning on the yield curve as opportunities present themselves.