Market overview

The first quarter of 2016 saw the expected rise in inflation on the back of a weaker rand came to head, as CPI increased 7% year-onyear in February versus 6.2% in January. The impact of the drought in South Africa has been earlier than expected with food inflation increasing 2.2% month-on-month. In light of this, the South African Reserve Bank (SARB) increased the key interest rate by 0.25% to 7% in March. The FRA curves (Forward Rate Agreement yields) now imply more than a 1% increase in rates over the next 18 months. The much anticipated SA budget was tabled in February and failed to allay fears of a sovereign credit downgrade, given continued execution risks on long-standing promises. Furthermore, rating agencies are faced with weighing up political risks with very mute GDP growth.

Portfolio review

The Fund delivered a 6.5% return over the past 12 months, 1% ahead of its ALBI 1-3 year benchmark. This performance was in line with peers. Performance of the underlying managers has been mixed over the year, pointing to the higher volatility in the market. While Investec outperformed through the Nenegate crisis in December by maintaining a short duration position, they continued to reduce duration through the bond market recovery, which lead to underperformance in the quarter. Prescient countered this by maintaining a long duration position and reducing credit exposure, which led to a good performance in the quarter. Aluwani Capital (previously known as Momentum) was also long duration during December and reduced slightly into the quarter. As a result, they could not fully capitalise on the fixed interest market recovery post Nenegate.

Portfolio positioning and outlook

In the face of a potential downgrade, our SA markets are likely to underperform other emerging markets that have benefited during the past quarter as there is more risk-on given that the US, UK and Europe are likely to be in a low interest rate environment for even longer. Within this context, the Fund’s overall cash position has increased by some 4% to 27%. This should act as a buffer if yields blow out and inflation surprises to the upside. Furthermore, Investec is particularly short duration which adds some defensiveness and a counter to Prescient and Aluwani who will capture the upside should the SA economic and political situation improve.