Bonds: The Tortoise Versus The Hare

Is it possible that the tortoise can beat the hare again?

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The last 5 years have been very disappointing for investors on the JSE. They have always been led to believe that equities outperform other asset classes and they must buy “stocks for the long-run.” Unfortunately, this has not happened, and the JSE All Share Index, like the fabled hare, has been soundly beaten again by the tortoise-like cash and bonds.

At first glance, Aesop’s fable, The Tortoise and the Hare, seems like moralistic propaganda. Slow and steady and is a good approach, but in real life, few would bet their money on the tortoise against the hare? However, this fable is probably best applied to investing where “getting to the finish line” is far more important than “getting there as fast as possible”.

No better example of this is the volatile market behaviour so far in 2020. Equities, property stocks and bonds fell suddenly in March due to the Covid-19 pandemic and have subsequently recovered a large part of their losses. Many investors were rattled and want to minimise damage while holding onto some stability that will ensure a measure of security in an uncertain future. As Philip Bradford, an award-winning portfolio manager for the Sasfin BCI Flexible Income Fund, points out, “People just want a decent return without having to take extra risk? They want the tortoise, not the hare.”

“Everyone wants high investment returns,” he says. “But many investors don’t want to, or can’t afford to, take risks. This is one of the reasons why bonds at current rates are a solid choice in this uncertain environment. A bond’s income and capital are guaranteed by the issuer, like a bank or a government, which provides a lot of certainty in an uncertain world. And for once, these bonds are cheap and offering high yields just at the right time. This makes them a robust choice for investors looking to minimise risk and still receive decent and stable returns.”

To mitigate the anticipated risk and volatility originally expected at the start of the year with the upcoming downgrade and existing market conditions, Bradford significantly increased the cash holdings in the fund so that it was well prepared to navigate this volatility. This meant that when the pandemic hit and its impact rippled across economies globally and locally, the fund had already de-risked and was conservatively positioned to avoid most of the fallout. It is now in a position to take advantage of the recent sell-off in markets and invest into high-yielding bonds that are likely to deliver consistent returns for many years to come.

“Many stock market investors are asking me – should I sell now or hang on and wait for a further recovery?  This is a textbook investor behavioural error called “anchoring” where investors hang on to their current investments hoping to get back to where they were before the sell-off. This is causing investors to ignore other good, lower risk opportunities”, says Bradford. “With cash yields at record lows the answer lies in SA bonds – they are cheaper compared to other emerging markets and they provide low-risk investors with the opportunity to lock in high returns.“

According to Sasfin’s analysis, the South African ten-year government bond is currently yielding more than double the cash yield, whilst the longer-dated bonds are providing a further 2% interest. With expectations of inflation falling close to 3%, investors who buy these bonds today will be locking in returns of over inflation plus 8%. These are the type of returns normally only possible from equities.

“We expect to experience further volatility of returns as we’ve seen over the past few months, but because we are still conservatively positioned and holding a lot of cash, we are well-positioned to navigate the turbulent times that lie ahead. We also know that the income from the bonds we hold is consistent and that it gets paid regardless of what happens to the underlying capital,” says Bradford. “Interest rates are going to fall even further and cash rates could easily fall closer to 3% by the end of the year if the economy doesn’t recover. This is the right time to buy fixed-rate bonds at high yields, locking in rates over 11% for our investors.”

“Over the next few years equities may recover, but the outlook at the moment is very uncertain it has been for the New South Africa. In this environment where cash rates will probably be around 3% for the foreseeable future, bonds are priced to provide the kind of inflation-beating returns that you usually expect from equities, but with less risk”.

Since inception nearly 5 years ago, the Sasfin BCI Flexible Income Fund has returned just over 55% cumulatively, whilst the JSE All Share Index returned only 11%. Is it possible that the tortoise can beat the hare again? It seems that the tortoise, being SA bonds, is poised to run a good race again.

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Philip Bradford

Chief Investment Officer, Sasfin Asset Managers

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