Stay abreast of COVID-19 information and developments here
Provided by the South African National Department of Health
ARE BONDS STILL A HEDGE
AGAINST MARKET VOLATILITY?
Sanlam Private Wealth
Sep 26, 2023
We believe we are getting closer to the end of the rate hiking cycle by major central banks. Markets are likely to remain volatile in the near term amid still elevated inflation and heightened recession risk, meaning the focus will remain on inflation data as a guide to central bank policies.
Both in the US and Europe, a strong labour market and resilient service sectors are supporting positive economic growth. However, industrial and real estate sectors are already suffering. As the higher policy rates by central banks and tighter lending conditions filter through the US and European economies, we’re starting to see a slowdown in economic growth. In China, economic data continues to disappoint with the housing market suffering from the unresolved crisis in the property sector.
The fierce policy-tightening programmes by central banks in the US and Europe have resulted in a sharp rise in short-term interest rates. Moreover, a tremendous amount of money has moved out of bonds into cash as investors have chosen to reduce their core bond allocations amid these hawkish central bank policies.
However, as higher rates filter through in the real economy, markets are starting to price in that the tightening of financial conditions will start to negatively impact economic growth and ultimately help bring down inflation. In our view, the risks are that central banks are overtightening and that there will be a stronger contraction in economic growth. This is also supported by historical analysis indicating that rate hiking cycles by central banks always end up in recessions.
Another (historically reliable) recession indicator is the inversion of yield curves, meaning that yields on shorter-dated bonds are now higher than yields on longer-dated bonds. This shows that bond investors are pricing in a slowdown of inflation and economic growth.
As the global economic outlook remains uncertain with the US and European economies having to digest higher rates and tighter lending conditions, while Chinese economic growth has fallen back significantly, we think it’s very likely that bonds will soon reassume their role as a hedge against equity market volatility. Whether you believe in a soft or a hard landing, the global economy is set to slow and central banks will ultimately respond by ending their respective rate hiking cycles.
As we are nearing the peak in interest rates and global yield curves remain very inverted, investors should take the opportunity to position effectively to benefit from the higher rate environment while also limiting risk given the uncertain economic and market outlook. Although it is likely that company earnings will also be under pressure in an economic slowdown, high-quality short-term debt typically performs well in such an environment. This represents a unique opportunity for investors wanting to benefit from a higher rate environment without taking significant duration risk.
While short-dated bonds typically trade at a premium compared to longer maturity bonds, it is now possible to achieve the same (or higher) yields in short-dated high-quality corporate bonds as in all-maturity corporates, but with around less than half of the interest rate risk. As such, this can be a powerful way for investors to boost their returns versus cash (without a material sacrifice in credit quality) or to maintain an attractive yield and credit spread, with enhanced protection from interest rate volatility.
In our RobecoSAM SDG Credit Income Fund, we primarily invest in short-dated global bonds with a focus on high-quality investment-grade bonds and high-quality BB-rated bonds. The fund has the flexibility to invest across developed and emerging markets to source the most attractive yield opportunities and is a good solution for investors wanting to benefit from the higher yield opportunities in shorter-dated bonds.
Another feature of the fund is that it has a clear sustainability objective, primarily investing in bonds issued by companies that positively contribute to the 17 United Nations Sustainable Development Goals (SDGs), and consequently avoids investing in bonds issued by companies that harm these goals.
The fund currently has a large allocation to financials, driven by the fact that we find the most attractive value in European bank and insurance debt. The larger banks in Europe are well capitalised and benefit from the higher rate environment, reflected in the strong earnings reported by banks. This is a tactical view. Once we see better value opportunities in other parts of the global fixed income market, the fund has the flexibility to change the asset allocation.
The interest rate sensitivity of the RobecoSAM SDG Credit Income Fund can range between roughly one and six years. We have gradually increased the duration to five years to benefit from both the higher yield environment and to serve as a hedge, anticipating that a higher interest rate duration can mitigate potential market volatility.
When market volatility increases because investors become more concerned about a slowdown in economic growth, we typically see a flight-to-safety effect where investors sell more risky assets and buy safe government bond debt. This will result in a decline in bond yields and should therefore benefit investors that have more interest rate duration in their portfolios.
The RobecoSAM SDG Credit Income Fund can invest across the US, European and emerging markets. The fund currently has a larger allocation to European debt – a tactical position primarily driven by our current preference for European bank debt. The fund has the flexibility to change the regional allocation if we see more value opportunities in other parts of the world.
The emphasis of the investments is on investment-grade corporate bonds and BB-rated high-yield bonds, where we see the most attractive yield opportunities and limited default risk. In addition, we hold some exposure in AAA-rated bonds and securitised debt, where we see attractive value relative to the high credit quality of these instruments.
Global financial markets will continue to be driven by rates and recession fears and although US and European yields seem close to the cycle peak, volatility and uncertainty remain. However, after the substantial increase in bond yields over the past two years, bonds now provide a very attractive yield and income, so they can once again increase diversification in an investment portfolio.
Bonds have historically played the part of providing income and a hedge against market volatility. We do think they will play this role again as we near the end of the rate hike cycle by central banks and as inflation starts to moderate.
However, as we still expect some rate volatility in the coming months, in our view, an investment in short-dated bonds is the best solution in the current environment. In addition, fixed income investors should emphasise quality in their portfolios with a focus on investment-grade and high-quality (BB-rated), high-yield bonds.
Comment by Renier de Bruyn, Head of Asset Allocation at Sanlam Private Wealth:
We have maintained a large underweight exposure to offshore fixed interest in our multi-asset portfolios over the past decade, as yields were supressed by central bank quantitative easing. As a result, the return prospects relative to those of equities have not been favourable. However, this has started to change over the past 18 months as monetary policy has become more restrictive, driving up bond yields.
We now see a more favourable risk-adjusted return outlook for fixed interest versus equities over the next cycle. Given the uncertainty around an economic slowdown on the one hand and inflation risk on the other, we prefer to invest in higher quality bonds while avoiding too much duration risk – similar to the view of Robeco above.
South AfricaSouth Africa Home Sanlam Investments Sanlam Private Wealth Glacier by Sanlam Sanlam BlueStar
Rest of AfricaSanlam Namibia Sanlam Mozambique Sanlam Tanzania Sanlam Uganda Sanlam Swaziland Sanlam Kenya Sanlam Zambia Sanlam Private Wealth Mauritius
GlobalGlobal Investment Solutions
Sanlam Private Wealth (Pty) Ltd, registration number 2000/023234/07, is a licensed Financial Services Provider (FSP 37473), a registered Credit Provider (NCRCP1867) and a member of the Johannesburg Stock Exchange (‘SPW’).
All reasonable steps have been taken to ensure that the information on this website is accurate. The information does not constitute financial advice as contemplated in terms of FAIS. Professional financial advice should always be sought before making an investment decision.
Participation in Sanlam Private Wealth Portfolios is a medium to long-term investment. The value of portfolios is subject to fluctuation and past performance is not a guide to future performance. Calculations are based on a lump sum investment with gross income reinvested on the ex-dividend date. The net of fee calculation assumes a 1.15% annual management charge and total trading costs of 1% (both inclusive of VAT) on the actual portfolio turnover. Actual investment performance will differ based on the fees applicable, the actual investment date and the date of reinvestment of income. A schedule of fees and maximum commissions is available upon request.
COLLECTIVE INVESTMENT SCHEMES
The Sanlam Group is a full member of the Association for Savings and Investment SA. Collective investment schemes are generally medium to long-term investments. Past performance is not a guide to future performance, and the value of investments / units / unit trusts may go down as well as up. A schedule of fees and charges and maximum commissions is available on request from the manager, Sanlam Collective Investments (RF) Pty Ltd, a registered and approved manager in collective investment schemes in securities (‘Manager’).
Collective investments are traded at ruling prices and can engage in borrowing and scrip lending. The manager does not provide any guarantee either with respect to the capital or the return of a portfolio. Collective investments are calculated on a net asset value basis, which is the total market value of all assets in a portfolio including any income accruals and less any deductible expenses such as audit fees, brokerage and service fees. Actual investment performance of a portfolio and an investor will differ depending on the initial fees applicable, the actual investment date, date of reinvestment of income and dividend withholding tax. Forward pricing is used.
The performance of portfolios depend on the underlying assets and variable market factors. Performance is based on NAV to NAV calculations with income reinvestments done on the ex-dividend date. Portfolios may invest in other unit trusts which levy their own fees and may result is a higher fee structure for Sanlam Private Wealth’s portfolios.
All portfolio options presented are approved collective investment schemes in terms of Collective Investment Schemes Control Act, No. 45 of 2002. Funds may from time to time invest in foreign countries and may have risks regarding liquidity, the repatriation of funds, political and macroeconomic situations, foreign exchange, tax, settlement, and the availability of information. The manager may close any portfolio to new investors in order to ensure efficient management according to applicable mandates.
The management of portfolios may be outsourced to financial services providers authorised in terms of FAIS.
TREATING CUSTOMERS FAIRLY (TCF)
As a business, Sanlam Private Wealth is committed to the principles of TCF, practicing a specific business philosophy that is based on client-centricity and treating customers fairly. Clients can be confident that TCF is central to what Sanlam Private Wealth does and can be reassured that Sanlam Private Wealth has a holistic wealth management product offering that is tailored to clients’ needs, and service that is of a professional standard.