Market review

Local bond yields traded stronger at the start of the quarter, while money market rates continued to move sideways. This happened on the back of a combination of offshore portfolio inflows, global monetary easing and weak local economic numbers. However, during May the investment environment changed drastically and we experienced increased volatility, particularly in the local currency and interest rate markets. The result was a sharp reversal in currency and bond market momentum. These movements happened on the back of a combination of a stronger US dollar, the fact that the US Federal Reserve Bank signalled it was considering the end of its quantitative easing program and significant portfolio flows in the local bond and currency markets. Globally, yields on bonds reacted negatively to the news and the US 10-year yield increased by 64 basis points (bps) during the quarter to a level of 2.49% at the end of June.

The rand exchange rate continued to weaken during the quarter and reached a weakest point of R10.3 to the dollar against a level of R8.5 at the end of 2012. It ended the quarter at R9.87 to the dollar. Although the inflation rate for May came in at 5.6%, expectations are growing that inflation could breach the upper target limit of 6% in the coming months, mainly as a result of the depreciating exchange rate. The Reserve Bank Monetary Policy Committee (MPC) left the repo rate unchanged at their scheduled meeting in May, in line with expectations.

On the back of these developments, the local bond yields ended the quarter sharply weaker along the yield curve. But we also experienced a flattening of the curve, as the long bonds increased less than the shorter-dated bonds. The money market yield curve also steepened, with the three-month rate ending 3bps higher at 5.15%, while the twelve-month rate increased from 5.66% to 5.83%. The R157 (three-year bond) traded at 6.08% at the end of the quarter versus 5.49% at the end of March, while the R2023 (10-year bond) traded at 7.57% at the end of June versus 6.82% at the end of March. The longer R209 (23-year bond) ended the quarter 43bps higher at 8.61%. The spread between the R209 and the R2023 bonds decreased from 137bps to 105bps during the quarter, which illustrates the change in the curvature over the quarter.

Real yields on inflation-linked bonds (ILB's) also weakened, with the yield on the R197 (10-year ILB) increasing from 0.77% at the start of the quarter to 1.62% at the end of the June. The 10-year implied inflation breakeven yield decreased marginally from 6.04% at the end of March to 5.95% at the end of June.

Against this backdrop, cash outperformed the other asset classes and delivered a return of 1.26% for the quarter, while nominal and inflation-linked bonds slumped 2.28% and 4.86% respectively. On the back of the flattening nominal yield curve, the 12+ years area outperformed the 7-12 years area and declined 1.51% and 2.28% respectively. The 1-3 years area was the top performing area, delivering a positive return of 0.35%.

Credit spreads remained stable amid the change in the level and curvature of the yield curve.

SIM strategy

We used the volatility in the market, liquidity opportunities and the attractive valuations of selective counters to restructure the portfolio during the quarter. We increased the allocation to quality corporate credit. Assets were invested in various maturities corporate credit. Assets were invested in various maturities across the money market yield curve during the quarter, increasing the diversification and enhancing the maturity profile of the Fund. The portfolio performance was driven by the diversified blend of attractively yielding credit assets, while the weakening in the nominal bond yields and real yields on ILB's had a adverse impact on performance during the latter part of the quarter.