We are not bullish about the short- to medium-term growth prospects for South Africa. The fiscus will likely continue deteriorating, given government’s ideological bent and its inability to execute. We also expect the private sector to continue not making capital investments locally, given either policy uncertainty or unfriendliness and better opportunities offshore. This view has kept us on the sidelines of most South African assets with the exception of South African government bonds (SAGBs).
SAGBs offer one of the most attractive yields in the world. These higher yields are a function of the risks of investing in South Africa. The bond market appears to be appropriately pricing these risks, but this does not seem to be the case in other local asset classes. (South African equities, for example, appear to be too expensive, given the high cost of capital and low growth prospects.) SAGBs should therefore be a cornerstone of any well-constructed multi-asset portfolio.
To invest in SAGBs, we believe you must accept the possibility of capital losses going forward as we expect yields to drift higher in the medium term, given both the local headwinds and the normalisation of yields in developing economies. However, the income yield available on SAGBs is so high that net of the capital loss, an investor could still generate a return of 9-10% per year on a 3-5 year view. Some investors may feel that this return is too low relative to the 8% available from cash. However, cash is not negatively correlated with the rand/dollar exchange rate and therefore does not offer the same ability to balance risk within a portfolio. Managing currency risk has become particularly important following the significant increase in the offshore allowance for Regulation 28 retirement funds in 2022.
According to our analysis, the most attractive part of the yield curve is the 6-9 year area. We believe the risk-return characteristics of the R2030, R213 and the R2032 are best for conservative or absolute return portfolios. While yields at longer-dated maturities are higher, they do not appropriately compensate investors for the risk that they present. And given that the local and global fiscal environments are not supportive of lower yields in the near term, we would consider any investment in the long-dated area of the curve to be speculative. Irrespective of the level of attractiveness of SAGBs, our fixed income allocation is not made in isolation within our multi-asset portfolios. We carefully balance this investment against growth assets which are critical for long-term inflation-beating returns.
