Market review
The first quarter of 2017 was a good (or bad?) mix of Trumponomics, populism and another bout of local political instability towards the end of the quarter. A significant cabinet reshuffle occurred on the evening of 30 March, including the removal of finance minister Pravin Gordhan. Global equity markets had a healthy quarter with tailwinds still prevailing from the promises of the Trump presidency while an uptick in developed market inflation was quite welcoming. After a pronounced sell-off in global fixed-income assets last quarter, most markets stabilised during the quarter. The Federal Open Market Committee raised US rates in March, as expected, but disappointed with a fairly balanced outlook on rates for the remainder of the year.

We can write a few pages on domestic issues, but we’ll stick to a few highlights (or lowlights). Minister Gordhan’s Budget hit consumers fairly hard and the fiscal space left in future has diminished significantly. During the quarter South African bond yields reached levels last seen prior to Nenegate while the rand reached lows of about R12.30/$, again wiping out much of the idiosyncratic risk premium. Some of these gains were, however, reversed towards the end of the quarter with the news of Gordhan’s replacement.

The rand strengthened somewhat over the quarter from R13.68/$ to R13.42/$ at the end of March. The 10-year RSA bond yield closed the quarter at 8.84% from 8.92% at the end of December. Generally, emerging market currencies did quite well over the quarter supported by upbeat commodity prices. Nominal bonds returned 2.5% for the quarter, inflation-linked bonds lost 0.6% and cash returned 1.8%. Listed property posted a gain of 1.4% for the quarter.

What we did
During the quarter bond yields reached levels last seen before the dismissal of former finance minister Nhlanhla Nene. A more favourable inflation outlook, stronger emerging market currencies and some initial stability on the local political front provided us an opportunity to reduce nominal bonds during the quarter. Some of these proceeds were reinvested into inflation-linked bonds as the breakeven inflation rate came down closer to 6%. Inflation-linked bonds at a real yield of above 2% are starting to look attractive on a relative basis. As mentioned, over the quarter the overall fund duration was reduced somewhat, while we continued to invest in selected corporate debt.

Our strategy
Credit spreads have, for the first time in a couple of quarters, started to narrow on robust demand from investors. But we still believe spreads are generally fairly priced, although some corporates appear to be on the expensive side. We remain of the opinion that South African fixed-income assets are still an attractive investment destination. Real yields of between 2% and 3% are on offer against the backdrop of declining inflation. Breakeven inflation levels have come down from previous highs, but we still prefer nominal bonds over inflation-linked bonds over the medium term. A portfolio yield of between 8.5% and 9.0% is achievable and bodes well for incomeseeking investors. Now let’s hope for some domestic political stability over the medium term.

Market review
The year 2016 will be remembered for a few big geopolitical surprises, namely Brexit and the election of Donald Trump as US president. Both of these events were largely driven by populism and protectionism. One could call it the 'revenge of the middle class'. The election of Donald Trump led to a sharp increase in US treasury yields (and global yields) as markets priced in possible fiscal stimulus from the US, deregulation and a possible increase in trade barriers. We saw a global sell-off in previously loved asset classes like property and bonds, while value stocks started to outperform substantially in the aftermath of the US election results.

On the domestic front we had to deal with ongoing political infighting, which led to frequent bouts of currency volatility. We started 2016 dealing with the aftermath of the 'Nenegate' episode and a weak currency. Fortunately, South Africa managed to retain its investment grade rating for the time being. The rand recovered some lost ground over the course of the year and closed at R13.68/$ from R15.49/$ the previous year. This off course affected all portfolios with offshore exposure significantly and reminded investors that the rand is not always a one-way bet, unlike the previous couple of years. One could argue that stabilising growth in China and significant infrastructure spend from the US will support commodity prices and hence currencies like the rand; the counter argument could be that rising global yields might exert a bit more pressure on emerging market currencies as a whole.

We maintain that we are close to the top of the domestic tightening cycle with the repo rate at 7%. Hopefully we'll also get some reprieve from a slowdown in especially food inflation during the course of the year. The 10-year RSA bond yield closed the year at 8.92%, down from 9.69% at the beginning of 2016. Nominal bonds had a fantastic year following the terrible 2015 and posted an annual return of 15.5%. Inflation-linked bonds returned +6.3% for the year, while cash delivered +7.4% for the year. Property posted a decent +10.2% for the year with most of it recorded during December (+4.3%).

What we did
Over the quarter the overall fund duration stayed fairly constant at about one year with little changes between the different fixed-income asset classes. We continued the process of yield enhancement although corporate credit looks expensive relative to bank credit spreads. Our clear preference for fixed-rate negotiable certificates of deposit (NCDs) and nominal bonds over inflation-linked bonds paid dividends over the calendar year, although, admittedly, we started 2016 at very attractive nominal yield levels. The fund comfortably exceeded the targeted return for the calendar year after a more testing 2015.

Our strategy
As stated last quarter, South African fixed-income assets remain attractive as an investment case, despite very good 2016 performances. Real yields of between 2% and 3% are still on offer in the fixed-income space with the yield of the fund comfortably approaching 9%. Although breakeven inflation levels have come down from the first-quarter levels, we still prefer nominal bonds over inflation-linked bonds over the medium term. Some of the possible headwinds for the local fixed-income market could be rising global inflation expectations, rising global bond yields and currency weakness from unexpected political surprises. On balance, we prefer to add to the overall portfolio risk, given the general favourable valuations.