It is very easy to be gripped by fear when reading the media or listening to the conversations of people from all walks of life.

The South African investment landscape has become a lot more volatile in recent months. Fear and uncertainty have taken hold and are affecting the way markets are currently pricing assets. We believe it is times like these that present opportunities for us to buy securities that are being been under appreciated due to fear.

As part of our philosophy, we always want to buy instruments into the portfolios that have a margin of safety. We currently believe that with all the fears in the markets due to global, political or economic events, the margin of safety in some fixed income assets has widened. Unfortunately, you cannot have your cake and eat it in markets - attractive real yield opportunities arise when there is fear in markets.

Let’s just look at the backdrop of fixed income markets and why we think there are opportunities which were not available over the last few years.

Inflation

Yes, locally inflation is on the rise, but the South African Reserve Bank’s (SARB) Monetary Policy Committee is sticking to their inflation targeting mandate and shows that they will increase rates to anchor inflation expectations. Globally, inflation is very low due to low commodity prices and inflation expectations abroad remain anchored.

Growth

Growth in most parts of the world is below expectations. Here in SA we continually see the SARB revise growth lower at every MPC meeting and the output gap remains. Globally, growth remains muted, causing the International Monetary Fund and World Bank to regularly revise these expectations lower.

Central Banks

Most developed market central banks are continuing with or adding more stimulus to global markets. We have seen the European Central Bank and Bank of Japan further reduce short-term interest rates into negative territory, trying to mitigate the unwanted effects of deflation. The most hawkish central bank currently, the US Federal Reserve, also had to turn on their heels and reduce their forecasts for further interest rate increases this year.

Looking at the factors above, this does not seem to be a world where bond yields suddenly rise to historic high levels and expose investors to large capital losses. A lot of bad news is already reflected in our local government bonds and we believe that the possibility of a downgrade and higher inflation is factored in. We think the margin of safety in bonds is wider than where it was three years ago and we are using this as an opportunity in the fund.

A Sovereign bond position is also a way of protecting our portfolios against a deflationary shock in the world, with the added benefit of being a liquid instrument in times of fear. This does not mean that the whole yield curve is an outright buy, but there are selective opportunities on the curve.

We are adding to the bond position on specific points of the nominal curve where the real yield has become more attractive given the duration risk. Longer dated bank Negotiable Certificates of Deposit remain attractive on a real yield basis given the level of risk and the expected path of inflation and interest rates.

The allocation to property has been sold from to the portfolio when the valuation became unattractive.

We will continue to search for real yields that are attractive at the level of risk.