The South African fiscal metrics continue to deteriorate. With increased expenditure, including cash injections into failing State Owned Enterprises (SOE) and below forecasted revenue growth, the market now expects a budget deficit in the October Medium Term Budget Policy Statement (MTBPS) north of 6%. As foreigners continue to sell SA bonds, it is clear they are demanding a higher risk premium than what is currently priced. Moody's credit analyst assigned to SA recently expressed a view that growth and fiscal metrics were likely to improve in SA, hence raising optimism that SA would not receive a downgrade in October. With the current growth and fiscal metrics in SA being poor, it will be interesting to see Moody's analysis of this comment post their credit review.

The SA government has moved the release of the MTBPS to the 30th of October. This is a worrying development as it only gives Moody's 2 days to assess interim budget steps before announcing the results of their rating review due for release on the 31st of October. Bonds continue to offer attractive real yields, but at heightened risk levels. With the deterioration in the sovereign balance sheet and continued warnings over Eskom and other state-owned entities, we believe a cautious stance is in order. The All Bond Index (ALBI) gained 0.51% for the month of September. Fund holdings consisted of credit exposure through banks and State-Owned Corporations, in both the bond and and cash markets, to take advantage of the additional pick-up in yield. The tactical allocation into Inflation Linked Bonds remained, as we are still of the view that there is value on offer, on both a relative and absolute basis. The Fund slightly outperformed the ALBI over the month. Credit spread compression contributed positively to performance. There were no detractors.

At its policy meeting in March, the US Fed indicated that it would not hike rates at all in 2019 whereas it was previously indicating two rate hikes. In addition, the committee decided it will stop its balance sheet reduction programme by September this year. This dramatic turnaround in policy has fuelled market expectations that the Fed will actually cut rates with time. The Fed's dovish policy stance and the "risk on" environment was generally supportive of EM bond markets over the quarter and as such masked the effects of a deterioration in the SA fiscal position presented in the budget. Also, Moody's did not downgrade South Africa as expected on its scheduled review date in March, which resulted in a rally of the domestic bonds. The All Bond Index (ALBI) gained +3.81% for the quarter. The yield curve steepened as yields on the short end fell by more than those on the long end.

The Fund was at neutral duration compared to the ALBI. Holdings consisted of credit exposure through banks and State Owned Corporations, in both the bond and cash markets, to take advantage of the additional pick-up in yield. Credit exposure and the resulting yield pick-up contributed positively to performance. There were no detractors from performance.