These days, the facts change fast. When the facts change, the view tends to change. However, at PSG Asset Management, we pride ourselves on being able to make long term investment decisions based on inputs that change less frequently than the views expressed by the market.
We reserve the right to alter critical assumptions that influence the valuations of various fixed interest instruments in the blink of an eye. However, the parameters that are changing are filtered through a fixed interest process that has been fine-tuned over many years. As a team, we debate our inputs rigorously on a monthly basis. We discuss the relative importance of many statistical, economic, market and financial variables in our models, and once we have reached consensus, we take decisions. Make no mistake, though, as we watch the financial shrapnel flying through the prism of our dealing room, we strategise and we act. We run various fixed interest funds with varying risk tolerance and return objectives. Certain low risk funds are targeting Cash returns. Others are targeting Cash + (1% -3%), and yet others are targeting Cash + 5%. Some of our fixed interest funds are blended into low risk products, and other funds rely on cash and near cash investments as a parking place in between bouts of risk aversion and over-valuation of equity investments.
When Governor Gill Marcus delivered the statement of SARB Monetary Policy Committee (MPC) on the 24th of May 2012, we were struck by three things. Firstly, at no point was there a discussion of whether or not interest rates would be changed at that meeting. Secondly, there was an emphasis that the SARB would not hesitate to act by either hiking or cutting interest rates, as required by the rapidly evolving global circumstances. There is now a very real possibility that the SARB might go through the entire up-cycle in inflation without having to hike interest rates. This would mean that the impact of rising inflation will be felt through a steepening yield curve. Once the peak of inflation has been confirmed, the yield curve will start to flatten again, and then long dated government bonds will start to offer value. At that point, we will look to start increasing the weight and duration of nominal government bonds in our bond portfolios.
In the background, however, we must not reduce the chaotic global backdrop to mere White Noise. Greece has defaulted and will likely default again. We are now treated to regular, inconclusive elections on a monthly basis, and we have seen regime change in Ireland, Spain, Italy and, of course, France. “Merkozy” is no more, but regime change in Germany will send shock-waves throughout the world and global financial markets. How does a South African bond investor invest when Europe’s debt capital markets are busy imploding? South Africa has an equivalent / better credit rating than several European Sovereigns, and lower bond yields than many. The ZAR is free floating, unlike the relatively homogeneous Euro which has not weakened as much as the European PIGS require, and is not as strong as the Germans demand. Thus we should buy short end SA bonds (or receive short rates) and look to accumulate longer dated SA bonds (or receive longer rates) into weakness. If the prices of oil & gold fall off a cliff due to a global recession and deflation, then we take our cue from the ZAR. If the weakness in the currency is less than that of oil, bonds become a buy. More simply put, watch the ZAR price of oil and gold. If the SARB is forced to cut again, the same applies. Look for value in the real rate space – inflation-linked bonds offer value anywhere from 2.25% to 3.00%.
Volatility will rise, and with it, opportunities for those with a strategic long term plan.