Bonds tend to be seen as safe havens for risk-averse investors. Is that still the case?
During times of high volatility and global uncertainty, it’s only natural that many investors are looking for low-risk, high-interest investments with guaranteed periodic payments. Fixed income investments would seem to tick all those boxes, providing access to interest-bearing markets… but are they a sound investment choice for you?
In the South African market, local fixed income assets have acted as a safe haven for investors for the past few years. However, the COVID-19 crisis and the various ratings downgrades, along with other disruptive events, has changed South Africa’s economic landscape. While the bond market may have been reasonably predictable in the past, a lot has changed in a short space of time and the investment opportunities and pitfalls need to be understood and addressed on a far more granular level.
“South African fixed income yields still offer some of the best value relative to other emerging market and developed countries’ bond yields,” says Anthony Palmer, Carrick Group Commercial Director. “This is attractive for lower risk investors in South Africa, as well as for international institutional investors who are looking for yield.”
As Palmer points out, those broader economic concerns should be part of an investor’s decision-making process. “South Africa government bonds do carry more risk than other countries’ sovereign debt, hence the higher return,” he says. “But most investors are comfortable with this risk, relative to the return they are getting.”
What are the Options?
“There are some very good flexible income funds in South Africa which have a more open mandate and generally invest in both South African corporate bonds as well as government bonds,” says Palmer. “It can get a bit complex when you drill down a little deeper, as some funds will manage duration while others are more focused on managing credit quality of the underlying holdings. These may include higher risk, high-yield (sub-investment grade) corporate issuers.”
As a rule, the longer the maturity of the underlying holdings, generally more yield is on offer, but with a higher duration. “Duration is the sensitivity of the fund to a change in interest rates,” Palmer explains. “As an example, a fund with a duration of 2 will have a 2% move in capital for every 1% move in interest.”
The question of whether a fixed income investment is right for you, depends on your risk profile and your investment goals.
Carrick’s income solution includes a carefully blended portfolio of five underlying holdings, which all work in tandem with each other. Some are focused on duration while others are focused on credit, which diversifies the portfolio.
In terms of risk, income funds have a risk rating of between two and three out of 10. They are generally best suited to clients who are comfortable with a six-month to one-year minimum investment horizon.
“We tend to use income funds for clients who want a low risk but higher than money market rate return” Palmer adds. “We also often use our income solution for living annuities to provide at least two years’ worth of income drawdown. The other buckets would include a core balanced holding and a satellite holding of 100% equities (offshore or onshore).”