The Fund’s return for the second quarter was 1.48% in rand terms compared to the benchmark return of -0.27%. For the year to date the return is 4.10% compared to the -0.69% of the benchmark. During the second quarter, developed market central banks began to grapple with how to approach the daunting task of unwinding years of unconventional monetary policy. The Fed addressed the next phase of normalization, which would entail tapering monthly asset purchases and shrinking its balance sheet. The US treasury yield curve flattened throughout the period, as investors sold short-dated bonds in favor of the longer end of the curve.

The European growth story was one of the biggest success stories of the quarter. Both core and peripheral countries generated economic momentum, as demonstrated by Portugal, which saw its entire yield curve rally after a sharp drop in unemployment and nearly 3% year-over-year GDP growth. President Macron’s victory in May, along with his party’s parliamentary majority one month later, helped French OAT spreads compress after widening to multi-year highs leading up to the election cycle. Regional elections in Mexico, which serve as a bellwether for general elections, helped Bonos across the yield curve rally. A surprise rate hike in May from Banxico helped sustain the rally in Mexican assets.

US dollar weakness was also an important theme during the quarter, though its significance was eclipsed by the relative growth story out of Europe, which helped lift many regional currencies. The euro (up 6.7%) rallied on positive economic data and ECB rhetoric. The British pound (up 3.7%) fluctuated between the announcement of the snap election and June results. During the period, the UK economy slowed more than expected while the Bank of England looked through rising inflation. The Swedish krona (up 5.8%) reflected the country’s open economy, which benefitted from regional and global growth. The pressure on Mexican assets continued to fall, helping the Mexican peso (up 3.8%) climb during the quarter.

China’s credit rating downgrade by Moody’s had asymmetric effects on emerging markets, having the greatest impact on countries that had significant trade relationships with China. Short and intermediate term Brazilian yields ended lower and the real (down 5.4%) did not entirely recover its losses. Local-currency Indonesian bonds rallied as the country entered into bilateral trade negotiations with the US; however the rupiah (down 0.1%) was slightly lower for the quarter.

Non-inflationary growth and search for yield helped US credit spreads narrow, while investors did not show imminent concern regarding the US default cycle. High quality, longer duration investment grade corporate and municipal credit performed well during the quarter.

Fund Review

The fund returned -7.2% in rands during the December quarter, also -7.2% in dollars (slightly behind the benchmark’s -7.1%), as the rand was flat against the dollar, but gained +5.2% against the pound and +6.8% against the euro. In the year to end December the fund did -9.5% in rands, or +0.9% in dollars (+20.7% in pounds and +3.9% in euros).

Mexican bonds (13.1% of portfolio at end September) had the biggest negative effect on the portfolio in the quarter of -0.24% relative to the benchmark, while US bonds had the biggest positive relative effect. The overweight in the British pound (9.5% of the currency allocation at end September and 15.4% at end December versus 5.2% for the benchmark) had the biggest negative effect from a currency standpoint, relative to the benchmark, followed by the overweight in the Aussie dollar (9.5% of the currency portfolio versus 1.3% for the benchmark). Otherwise the portfolio remains similar to end June and end September. The modified duration is up a bit from 5.5% to 5.9% (was over 7% in March) and the current yield is up from 4.1% to 4.3%, but is still much higher than the benchmark’s 2.6% yield. The fund increased its holding in US bonds from 32.6% to 36.1% (benchmark 39.2%), but remains very underweight in the dollar, (23.2% versus 45.5% for the benchmark). The fund has a tiny position in the euro of 0.1% (benchmark 23.8%), zero in the yen (benchmark 17.1%) and 15.4% in the pound (benchmark 5.2%). Government-related bonds comprise 64% of portfolio, with 0% in high yield bonds. Cash comprised 12% at end December (14% at end September). The Mexican peso is at 12.3% of the currency holdings (13.1% at end September) and the rand is 5.4% (same as the bond portfolio.

Looking ahead

Brandywine, the fund manager, believes the role of fiscal policy will rise to prominence in 2017. Emerging markets will have plenty of room to cut rates if global growth remains challenged, although they expect better growth. They believe that stimulus in China and Fed policy will remain the largest determinants of global growth. They still expect long-term safe-haven yields to remain capped on the upside. They still believe that select emerging market debt offers the most attractive sources of yield and potential currency return among their investible universe, especially select commodity-linked currencies.