Fund review

The STANLIB Income Fund continued to deliver good performance for the quarter, bringing the one-year return to 9.8%. The fund’s modified duration moved from 0.36 years to 0.56 years for the portfolio to benefit from expected interest rate cuts. Credit spreads generally moved sideways during the quarter. Inflows into the fund continued throughout the third quarter, with the fund size increasing from R41.3 billion to end the quarter at R44.6 billion.

Market overview

Ongoing global trade tensions continued to affect confidence negatively in Q3 2019, putting further strain on emerging market assets. The rand was on the back foot, losing about 6% against the dollar, while the 10-year benchmark government bond was almost 20 basis points weaker at the end of the quarter. The global backdrop still remains supportive for emerging market bonds due to an increasing number of negative-yielding bonds in developed markets and lower-trending inflation globally. The US Federal Reserve cut interest rates for the first time since the financial crisis, indicating that these are midcycle cuts to provide “insurance” against weaker growth rather than a longer-term policy change.

The Fed’s cuts have encouraged emerging market central banks, including the SARB, which are facing declining inflation and slowing growth, to follow suit. This provides further support for emerging market yields to perform well despite the volatility driven by the US/China trade war. SA’s headline inflation moderated to a low of 4% y/y in the quarter, and is expected to average 4.2% for the year. The SA government issued a eurobond that was over-subscribed, raising $5 billion instead of the $4 billion that was planned initially. This will go a long way towards improving the government’s funding requirements ahead of the MTBPS late in October. There has been some compression in the yield curve as the government is not considering any more switch auctions for this calendar year, which eases pressure in the ultra-long end of the curve with issuances.

At a conference held in SA in September, Moody’s stated that SA’s fiscal deterioration over the past decade has been in line with the median Baa3 countries. This improves SA’s prospects of avoiding a downgrade, with the worst-case scenario being an outlook change from stable to negative. Moody’s sees the structure of SA’s debt as having lower refinancing risk than its peers. The South African CDS spread is trading wider than comparable peers that are already in junk territory, meaning that the markets have already priced in a downgrade to junk status. A reprieve by Moody’s would give SA an opportunity to produce a credible economic restructuring plan to deal with its persistent fiscal slippage and stimulate economic growth prospects. If there is no downgrade, this will be positive for the bond market.

Looking ahead

With survey data in the US and eurozone continuing to indicate a slowdown in growth, coupled with dim growth prospects locally and inflation firmly inside the target range, local bonds are still expected to offer attractive returns given their compelling real yields in comparison to peers. The wider currency and credit risk premiums built into bond prices are expected to gradually unwind after the October MTBPS and Moody’s rating announcements. Globally, the ECB will resume its open-ended quantitative easing programme in the fourth quarter and the Fed is expected to continue cutting interest rates to manage the slowdown in the US economy. This leaves room for the SARB to cut rates in November.

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 STANLIB Income Fund continued to deliver good performance for the quarter bringing the one year return to 8.8%. We maintained a defensive positioning, slightly reducing modified duration of the Fund to 0.36 years from 0.4 years. Credit spreads generally moved sideways during the second quarter. Inflows into the Fund continued throughout the second quarter, with the Fund size increasing from R37.7 billion to end the quarter at R41.3 billion.

Market overview

South Africa experienced a weaker than expected GDP growth as the economy contracted 3.2% on an annualized basis in the second quarter, highlighting the growth challenges facing President Ramaphosa following the May election victory. The decline in GDP was largely broad-based, with manufacturing and mining production contributing the most, leading to the rand to weaken to R15/$ for the first time since September 2018. The ruling party officials entered a debate on the role of the South African Reserve Bank to expand its mandate with some calling for measures such as quantitative easing to support growth. However, this did not gain much traction with President Ramaphosa later issuing a statement affirming the SARB mandate in addition to the joint statement issued by the SARB and National Treasury assuring the independence of the reserve bank.

The MPC remains dedicated to anchoring inflation expectations to the 4.5% midpoint of the CPI target range, but acknowledged inflation expectations have declined fuelling speculation they may ease policy. This is reflected by the Forward Rate Agreement (FRA) curve which is fully pricing in a 25bp rate cut in July.

The prospect of policy easing has driven bonds in the short-end and belly part of the yield curve to rally, but long dated bonds have been negatively impacted by the country’s deteriorating fiscal position and lacklustre economic growth. Moreover, the government was also forced to pay R5 billion in emergency funds to meet Eskom's debt obligations in April, a move that possibly prompted Moody’s to consider incorporating the utility’s debt a part of the government debt. President Ramaphosa recently announced that additional support will be provided to Eskom by bringing forward part of the R230 billion rand reserved for the utility over the next 10 years. The impact on bond issuance remains unclear, but the spread between the SA benchmark bond yield and the 25 year bond yield widened to an all-time high of 185 basis points before tracking back to 161 basis points by end of the quarter.

Trade war uncertainties continue to negatively affect global markets, reduce confidence and global economic growth. Negotiations between US and China fell apart in
May after the threat by the US President Trump to raise tariffs further escalated tensions between the 2 countries. A month later at the summit of leaders of the Group of 20 (G20) U.S. President Trump and Chinese President Xi Jinping agreed to resume negotiations at their meeting. Subdued U.S. economic growth and muted inflationary pressures has tilted the U.S. Fed into a dovish stance with the market fully pricing in a 25bp cut at the Fed’s July meeting.

Looking ahead

The improved backdrop for global interest rates will dominate global market movements potentially boosting risk assets around the globe, but SA may lag if investors
choose to focus on the relatively unattractive domestic story. The Fed is set to dominate global markets, with communication from Fed Chairman Jerome Powell signalling
that they are open to rate cuts for the first time since the global financial crisis, which is positive for EM markets. Moreover, ECB officials are worried about the economy and inflation with outgoing ECB President Mario Draghi citing the possibility of another round of monetary stimulus. This creates an opportunity for SARB to also cut rates given the challenging growth environment and benign inflation outlook. Rating agency Moody’s is not expected to move on the sovereign rating as they look to further assessing government on implementing policies to resolve credit challenges and boost economic growth. Plans to deal with the country’s deteriorating fiscal position and funding Eskom along with other SOE’s will be the key focus for National Treasury, details of which will be shared in the Medium Term Budget Policy Statement in late October.

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

Flows into the STANLIB Income Fund continued throughout the first quarter, with the fund size increasing from R32.5 billion to end the quarter at R37.7 billion. Volatility in the markets due to both local and international data prints and uncertainty around the global growth outlook led to investors reducing risk by allocating money to income funds. The fund’s returns remain attractive compared with money market returns due to high yielding assets in the portfolio. The modified duration of the fund was maintained at 0.4 years. Credit spreads did not change much during the quarter, further benefiting the portfolio.

Market overview

In the first quarter of 2019 there were a number of key risk events, starting with the Budget speech when the Finance Minister presented worsening fiscal projections. The budget showed debt to GDP figures exceeding 60% in the medium term along with R69 billion support needed for financially distressed Eskom over the next three years. The cash injection came at a much-needed time, as Eskom was allocated a lower tariff increase by NERSA than it applied for and the power utility was also reaching a point where it was unable to service its debt. This, with loadshedding, contributed to weaker business confidence. Credit rating agency Moody’s gave SA a rating reprieve by deciding not to issue a sovereign credit review on 29 March, but later issued a credit opinion affirming SA’s credit rating at Baa3 with a stable outlook. The credit opinion mostly highlighted positives, causing markets to rally, with the SA benchmark bond yield reaching a low of 8.42% for the quarter and the rand strengthening to R14.15/$ from a low of R14.60/$. The five-year credit default swap (CDS) spread consolidated to 185bps, down from 227bps at the beginning of Q1 2019, but still higher than the low of 140bps seen in 2018. Despite volatility, the bond market managed to produce a return of 3.76% during Q1 2019.

At its December meeting, the US Fed emphasised slowing global growth and benign inflation, which encouraged it to pause from hiking interest rates and announce an early end to its balance sheet reduction in Q3 2019. The Fed’s changed stance, along with other global central banks remaining accommodative, has rallied high-yield emerging markets. The US 10-year bond yield has since strengthened to 2.37% following a high of 2.75% earlier during the quarter. However this caused the US yield curve to invert, which raised concerns of a possible recession in future. In line with a benign global inflation outlook, inflation data in SA remained subdued, supporting the bond market.

Looking ahead

The market will be closely watching the national elections taking place on 8 May and the outcome may influence direction. The risk of an imminent sovereign downgrade may have subsided but it is not completely ruled out as Moody’s continues to monitor the turnaround in SA growth and fiscal metrics. Moreover, Moody’s rating review of the SA sovereign scheduled for November will consider the structural reforms undertaken at financially troubled state-owned companies such as Eskom. Inflation in SA is expected to remain stable inside the target band of 3-6% and the SARB is likely to keep rates on hold for the year.

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

Flows into the Stanlib Income Fund continued throughout the third quarter, with the Fund size increasing from R31.4 billion to end the quarter at R33.2 billion. The volatility in the markets which came as a result of emerging market jitters left investors to seek diversification into income funds. The Fund’s returns remain attractive compared to money market returns due to high yield assets in the portfolio. The Fund still maintains a defensive positioning which was beneficial given the recent upsurge in bond yields during the quarter. The modified duration of the Fund was maintained at 0.5 years. Credit spreads continued to tighten during the quarter, further benefiting the portfolio.

Market overview

Emerging market currencies and assets continued to sell off in the third quarter amid a stronger US dollar environment as trade and geopolitical tensions heightened, monetary conditions continued to tighten and global inflation expectations accelerated. Risk aversion due to US sanctions on Turkey and Russia and the debt crisis in Argentina contributed to the rand weakening by 3% against the US dollar, with bonds following suit as foreign investors sold R16bn of South African government bonds in the quarter. The US Fed raised interest rates by 25bps in September as widely expected, and indicated that they are planning on raising rates once more this year and three more times in 2019 as growth remains robust and inflation continues to increase. Local GDP surprised by contracting again in the second quarter, tipping the economy into a technical recession and sparking fears of a possible ratings downgrade by Moody’s on the 12th of October. Longer dated bonds sold off as a result, as markets were pricing in a higher probability of an increase in government bond issuance as tax revenue was likely to come under pressure. The spread between the 30 year maturity bond and the 10 year maturity bond increased by 10 basis points to end the quarter at 93 basis points, reflecting these risks. Headline Inflation increased from 4.4% to 4.9% in August due to higher fuel prices and higher VAT but core inflation remains subdued as the economic activity remains subdued. The Reserve Bank as a result left interest rates unchanged leaving the markets pricing in higher probabilities of an interest rate hike at their November meeting should the current negative environment persist.

Looking ahead

The fourth quarter comes with a number of event risks with possible significant impact on returns. The three major rating agencies will give their rating updates on South Africa; with the Moody’s decision the most important one as a downgrade from them would result with major outflows due to South Africa being excluded from the World Government Bond Index. In September the government tabled measures to stimulate economic growth, details of which will be shared in the Medium Term Budget Policy Statement in late October. The stimulus package was well received by the markets and the details in the budget will be assessed for the impact on National Treasury’s debt consolidation plans. The Land Reform Committee is also expected to report back to parliament on its recommendations, which can have material impact on markets. Internationally, elections in Brazil in October and in the US in November will also be watched with keen interest as they can influence the risk environment. 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.