Fund review

The fund returned 5.38% for Q3 2019 (YTD: 10.24%) compared with the benchmark return of 7.77% (YTD: 11.61%). The portfolio’s weak performance during the third quarter was almost entirely due to the currency contribution. Duration provided significant absolute returns and came both from holdings of Treasuries as well as from emerging market bonds, with Mexican and Brazilian bonds powering the gains. The rand ended the quarter weaker at R15.17/$ after trading at R14.08/$ at the end of June 2019. The rand remains volatile due to economic uncertainty and a low growth environment in SA.

The fund grew in market value from R953 million at the end of June 2019 to R993 million at the end of September 2019.

Market overview

Yields fell across the curve, as the 10-year Treasury posted its largest quarterly decline in several years, and the 30-year bond yield hit a record low in August. This drop in global rates sent investors searching for yield during the quarter, and emerging market debt generally rallied modestly.

As for the substantial negative drag from currency contribution, the portfolio is underweight US dollars, yet the dollar rose steadily throughout the quarter against almost all currencies. The sustainability of this trend is the key issue for positioning going forward. An underweighting in the euro and lack of exposure to the yen were positive exceptions, but exposure to a basket of foreign currencies was detrimental in the strong US dollar environment.

There was very little change in the portfolio positioning during the third quarter. In terms of duration, the portfolio largely sustains its barbell profile: duration in US Treasuries counterweighted by duration in the emerging world, with particular emphasis on Mexican sovereign bonds. The barbell structure makes sense from a risk management perspective, given the global crossroads macro theme moving forward. However, this structure was not a result of implementation around that macro uncertainty. Instead, the duration allocation arose out of a normal price discovery process and where we believe value resides in the global fixed income market.

The fund is overweight emerging market bonds, which paid off during the third quarter. Despite dollar strength and emerging market currency weakness, local currency bonds across the emerging world continued to rally in step with developed country markets. The breadth of the rally attests to the deflationary forces at play in the global economy.

A sizeable position was committed to US Treasury duration in the fourth quarter of 2018. The rally in bond prices since then has dramatically reduced the price opportunity to such an extent that this position was reduced during the most recent quarter. Upside in Treasury prices from here seems limited, unless the world economy goes off the rails.

The extraordinary gains in the dollar during the third quarter do not seem sustainable. A gradual decline in the dollar is expected due to it being expensive, improvement in the trade standoff, an expansionist Fed and economic stabilization in China, all of which is dollar negative.

There is a small but growing possibility of some form of intervention to contain the dollar’s strength. President Trump has been critical of the Fed for helping to support the dollar at a time when balance of payments factors argue that the euro is structurally very cheap. The weakness in the renminbi that largely corresponded to the increase in US tariffs on China was not lost on the President either, as he declared China to be a currency manipulator.
Looking ahead

The big move in bond prices is probably nearing an end in most of the developed world. However, that is not the case in emerging markets. More interest rate cuts are in the pipeline, both in the US and abroad. The engine for return in the portfolio will be dollar depreciation in response to the three crucial variables of the dollar noted above. We believe the Fed will cut interest rates by another 50 bps, the Chinese will continue to stimulate and, most importantly, the trade negotiations will be driven by political and economic self-preservation.

The commentary gives the views of the portfolio manager at the time of writing. Any forecasts or commentary included in this document are not guaranteed to occur.

Fund review

The fund returned 3.42% for the first quarter of 2019 compared to the benchmark return of 2.44%. The year to date outperformance can mainly be attributed to the increased exposure to the US coupled with the weakening of the South African rand. The rand ended the quarter weaker, at R14.50/$, after trading at R14.38/$ at the end of 2018. The rand remains volatile due to economic uncertainty and a low growth environment in SA.

The fund grew in market value from R844 million at the end of 2018 to R913 million at the end of March 2019.

Market overview

Performance during the first quarter was strong, with support coming from both currency and bond market positioning. The biggest contribution to absolute performance came from the bond overweight positions, with U.S. and Mexican duration delivering the bulk of the gains. An overweight position in U.S. Treasuries and short-dated U.S. dollar-denominated corporate bonds contributed positively to performance. As the Fed lowered expectations for near-term rate hikes, Treasury yields rallied and finished the quarter lower along the curve. Lower rates and the benign Fed outlook also fostered a constructive environment for both investment grade and high yield corporate bonds. An overweight to long-dated, local-currency Mexican bonos position was particularly beneficial to returns. Bonos also rallied across the yield curve, buoyed by the Bank of Mexico’s stance, the more dovish Fed outlook, improving economic activity, and rising commodity prices. Indonesian bonds also added gains to the portfolio, rallying as the Fed’s new dovishness enabled the Indonesian central bank to keep its policy rate steady. The lack of exposure to Japanese sovereigns and low-yielding European duration detracted from performance as most developed bond markets participated in the broad bond rally during the quarter.

The most significant contributor to relative performance was currency positioning. The portfolio did not own euros, which weakened early in the year, accounting for the majority of the currency attribution. The remainder came from positioning in emerging currencies, including the South African rand, Malaysian ringgit and Indonesian rupiah, with the biggest return coming from the Mexican peso. The most detrimental currency exposure was to the Swedish krona, which continued to bear the brunt of questionable Riksbank policy compounded by weak inflation and disappointing retail and manufacturing data.

Looking ahead

The portfolio remains broadly underweight the dollar. Duration is roughly equally split between U.S. exposure, mainly in long-term Treasury bonds, and select emerging market local-currency sovereign bonds. The overall effective portfolio duration is slightly below the benchmark.

Duration in other developed country markets remains virtually absent. The rest of the duration exposure remains invested across numerous emerging country sovereign bond markets, the largest and most persistent being an unhedged allocation to Mexican bonos. A gradual stabilization in the global economy with suppressed yields in the developed world is an inviting scenario for yield compression with the developing world.

The fund also remains significantly underweight U.S. dollars with a bearish outlook. Global economic data may continue to weaken owing to time lags, but policy shifts from the China and the U.S. should lead to a reversal of the deteriorating global economic trend. We believe this development will benefit the emerging market overweight position.

The commentary gives the views of the portfolio manager at the time of writing. Any forecasts or commentary included in this document are not guaranteed to occur.

Fund review

The Fund’s return for the third quarter was 2.25% in rand terms compared to the benchmark return of 3.71%. The fund returned 10.66% for the year to date, compared to the benchmark year to date return of 11.81%. In dollar terms the fund outperformed the benchmark by 0.18% for the quarter. The year to date outperformance can mainly be attributed to the weakening of the Rand against the US Dollar. The Rand closed the quarter off at R14.14 to the US Dollar after trading at R13.73 at the end of June 2018. This resulted in the fund making positive returns in rand terms. The Rand is still volatile due to economic uncertainty and a low growth environment in South Africa.

The fund increased in size from R825 million at the end of the first quarter to R827 million at the end of September 2018.

Market overview

Performance during the third quarter began to stage partial recoveries from the relative drawdowns that took place in the second quarter. Despite coming under pressure in August amid a broader selloff in emerging market assets and currencies, the Mexican peso recovered strongly in the wake of a new trade deal with the U.S. and Canada. However, Mexican government bond yields were higher across the yield curve for the quarter, and the portfolio’s exposure to longer-dated Mexican bonos detracted from results. Attribution was positive against the yen and euro as well, owing to our underweights relative to the benchmark. Interest rate differentials between the U.S. and Japan, a hawkish Federal Reserve, and trade uncertainty sent the Japanese yen lower against the U.S. dollar. Reduced European growth expectations and Italy’s rising political risks, including a surprise move by the new government approving a significant increase in Italy’s budget deficit, weighed on the euro. Accordingly, lack of exposure to Japanese and Italian bonds benefited the portfolio during the quarter. Our decision to overweight the front end of the U.K. bond market was positive as longer-dated gilts sold off and yields rose amid ongoing uncertainty around Britain’s withdrawal from the EU. Although primarily utilized for cash management, U.S. investment grade corporate bonds contributed to quarterly results. These gains were offset by marginal declines across our emerging market (EM) currency positions. Trade tensions, weakening global growth, and a stronger U.S. dollar all weighed on emerging markets during the quarter. In particular, August witnessed a sharp selloff that began with Turkey and Argentina. These markets triggered a broader rout and a general shift among investors toward risk-off behaviour mid-quarter. Exposure to Turkish bonds and the lira detracted from overall results, as did unhedged sovereign bond positions in South Africa and Indonesia. The Turkish lira fell victim to U.S. sanctions and concerns over the efficacy and independence of the central bank. South African yields were modestly higher for the quarter due to selloffs triggered by weak economic data and emerging market spill over effects.

Looking ahead

Heading into the final quarter of the year, the portfolio largely retains its overall structure: underweight global duration but with duration concentrated mainly in select emerging markets. Heavy weightings continue in Mexico, Brazil, South Africa, and Indonesia with underweights to the U.S. dollar, the euro, and the yen in favour of the emerging world.

The commentary gives the views of the portfolio manager at the time of writing. Any forecasts or commentary included in this document are not guaranteed to occur.