Long road to recovery even once the economy begins to re-open

Rashaad Tayob, Portfolio Manager of the Nedgroup Investments Flexible Income Fund discusses the long road to recovery after lockdown.

We’re heading towards the end of week 4 of lockdown and, looking at global trends, many countries are moving to a lower level of lockdown and realising that the economy and society can’t remain shut for ever – so we expect some level of relaxation and a step down in the very near future.

The Nedgroup Investments Flexible Income Fund’s performance, relative to the STEFI benchmark, has been able to outperform in the long term. However, on the quarterly and one-year numbers, given what happened in March, there was a step down. Some of this has begun to unwind, but it’s going to be a relatively long road to recovery even once the economy begins to re-open.

Let’s get the bad news out of the way by looking at how each asset class fared in Q1. Total gross return was -1.9%, the worst quarter we’ve ever had. Offshore was a positive contributor at 0.4% largely due to the weak rand as was SA cash, although we feel it should have been a bigger contributor of closer to 2%. Given the extent of the bond selloff, SA bonds was a detractor. While the highest detractors are relatively small components of the total fund, being SA property and preference shares, they were the biggest drivers of negative performance due to the extreme moves in those sectors. We believe that a lot of the selloff is temporary in nature and we’ve already seen a decent recovery such as SA bonds, so we haven’t cut any allocations.

South Africa is not out of the woods yet. Going into this crisis we were in a relatively weak position running a significant fiscal deficit. Given Covid-19, we will need some aggressive action with a recovery plan and financial policy response to help the economy to re-open and recover.

In terms of the portfolio’s position, SA cash and money market (35.3%) are large components of the fund. Inflation-linked bonds (5.5%) is a key asset class in South Africa and is an area where we have been adding. Real yields have moved up from sub 1% to about 4%. It’s an area where we’ve seen a lot of value and, in the last week, and have been adding a lot of that as we do have a good cash component where we can take advantage of higher Rio yields. We’ve been as high as 20% in this fund and I think we’ll add a good component to inflation-linked bonds in the coming months. 10% of our bonds are SA government bonds while the other 25% is hedged into floating rate assets with no interest rate risk. Our SA preference shares are a floating rate component where we’re getting 12% -13% on the big banks. It has come under pressure, but at these levels offers a very attractive return outcome and we think that the 1% capital loss that the fund suffered can be reversed.

We haven’t sold on the property side, which is a high yield contributor. As this is a real asset, as the markets stabilise, we believe this sector will recover. Foreign cash and bonds have come under pressure. We have been conservatively positioned and our weighted average term on our offshore component is just one year with a Dollar yield of 12%, so this area of the Fund has a great yield return potential going forward. Overall, with a duration of 0.8 years, the fund’s yield is 8.7% and is still relatively conservatively positioned. We expect it to go down over the next 3 months as floating rate assets reset along the lines of a 30-40% bps reduction in yield.

Yield by asset class

Foreign fixed income: 6.5% largely driven by the offshore bond component which has a 12% yield.
Property: 18.4% This is a trailing yield and we don’t think given what’s happening in that sector this will be delivered in terms of dividends, but it does give an idea of the extent of the selloff in this sector.
Fixed rate bonds: 9.9%
Inflation-linked bonds: 8.5%. This is an area where we’ve been adding.
SA cash & money market: 7%. Given the interest rate cuts, this has diminished somewhat but it’s a very low-risk component.

Landbank

We also have a component of Landbank, just under 4%, in the fund. They are experiencing short-term liquidity constraints and unable to pay its short-term debt facility and will have to draw down on the R5.7 billion that was given to them in the form of guarantees in the last budget. They are, however a critical SOE for SA as they fund the agricultural sector. Landbank has been attempting to reach 20% short-term funding (from 80%) and 80% long-term funding (from 20%) levels but the crisis has stalled that funding strategy and they are currently at 50% for each. The government has been very aggressive in supporting Landbank and we believe that Treasury will add to the existing guarantees if that becomes necessary. 
 
SAA
 
We need to get to a resolution regarding SAA so it stops being a R5 – 6 billion a year drag on Treasury as it has been for the past 2-3 decades. We are at the point where we can’t throw that type of money away when SAA only employs 4500 people. Cabinet, who has not grasped the seriousness of the problem, has opposed all talk of shutting SAA down so Treasury has been unable to get the reforms it wanted. We were looking at SAA as a sign that government was reflecting on the seriousness of the problem and the willingness to shut down SAA and stop the drag on the fiscus, which we definitely couldn’t afford now.

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