Fund Review

The Fund is largely invested in floating rate notes, which provide a level of capital protection given that short term rates are now firmly on the upside. The Fund's returns continued to best money market returns, but with the advantage of a defensive positioning in terms of modified duration which was at 0.29 years compared to 0.35 years during the last quarter of 2013. New cash inflows were invested in the primary corporate debt market.

Looking Ahead

The first quarter of 2014 opened with more volatility when compared to last year. The ALBI benchmark returned 0.9% during the first quarter after the market staged a late recovery. The RSA 10 year bond traded to a high of 8.90% before ending the quarter at 8.39%. The 12 months NCD rate increased from 6.025% to end the quarter at 6.975%.

Returns for longer-dated maturities were a lot better than shorter-dated bonds. The budget speech was received well by the market, although the supply of bonds from the government will still be concentrated in the long end of the yield curve. The demand for risk assets globally improved in March as emerging markets in general benefited from the risk-on trade. Foreigners who had shunned emerging markets started to warm up to them as they looked cheap relative to developed markets on a carry trade basis. The extent of the volatility is evidenced by the path of the JP Morgan EMBI spread which started the quarter at 332 basis points (bps), touched a high of 406bps and retraced all the loses to end the quarter at 326bps. These gyrations catapulted the Rand to a low of R11.50 before recovering to end the quarter at R10.52. Foreigners ended up being net sellers R4 billion South African bonds which was much better than at the height of the sell-off.

The sell-off in the Rand led the SARB to revise higher the currency pass through risks to inflation, and hiked the repo rate by 50bps. The rates market sold off aggressively, particularly in the short end of the yield curve, with the forward rate agreement (FRA) discounting a further 2% in rate hikes. The SARB, however, dampened those expectations and as a result the market retraced. The impact of the hike led to an aggressive flattening of the yield curve, with the yield differential between the R186 2026 and R157 2015 paper compressing from 210bps to a low of 130bps before correcting to end the quarter at 160bps. The outlook for interest rates is now firmly on the upside as inflation is expected to breach the 6% top of the target range. The market is already discounting the hikes as the FRAs have adjusted higher. The path for South African bond yields will also be firmly linked to the US treasuries movements in the face of tapering and potential early hikes in 2015.