Strategic opportunities in Fixed Income: A Portfolio Opportunity

Should you be allocating more of your wealth to fixed income assets?

Investors are constantly searching for ways to better manage their portfolios and achieve high returns. Fixed income assets make a compelling argument for consideration, especially in today's South African economy. There are various benefits to allocating more wealth to fixed income assets and knowing how they could serve strategically in a diversified portfolio.

Understanding Fixed Income Assets and Portfolio Management

Fixed Income as an Asset Class has historically been used as a more defensive asset in portfolio construction. The total return of bonds is comprised of two components, the income stream and the capital / price movements of the asset. In South Africa, the average income paid out from bonds (All Bond Index) is approximately 10.5%. When bond yields decrease the price goes up and vice versa - this is the capital return component of a bond. Based on current forecasts, bonds are expected to return between 15 and 20% over the next 12 months.

Over the last 10 years (ending May 2024) the annualised ZAR return of Domestic Equities (FTSE/JSE All Share Total Return Index) was 8.04% and Bonds (FTSE/JSE All Bond Total Return Index) returned 7.76%, compared to 12.69% for Global Equities (S&P 500 Total Return Index) and 1.26%  for Global Bonds (Bloomberg US Aggregate Total Return Index) in US dollars.

The reason for relatively poor performance of Domestic Equities is simple; South Africa has been plagued by a decade of extremely low growth with GDP growing just 7.1% since 2014. GDP has grown from 4,331,667 (R millions) in March 2014 to just 4,640,222 (R millions) in March 2024. This is an annualized growth rate of just 0.7% pa. Certainly not conducive to any meaningful growth of wealth.

Historical Performance of Fixed Income Investments in South Africa

At the same time the cost of capital in South Africa has increased significantly over the past 10 years. For example, the 10-year bond is yielding almost 12% compared to about 8.5% a decade ago. This presents a unique opportunity to capitalize on Fixed Income as an effective growth asset in one’s portfolios. The FTSE/ JSE All Bond Index which is currently yielding 10.4%, is therefore offering a real return of over 5% pa. Using the current 10-year SA Government Bond yield as a predictor of returns from bonds over the next 10 years, one could expect almost 12% pa, or a real return in excess of 6% pa. Such returns are typically associated with long-term growth assets such as equities in the construction of one’s diversified wealth portfolio.

Fixed Income in a Rising Interest Rate Environment

Understanding how fixed income investments perform in various interest rate environments is crucial. Generally, rising interest rates can negatively impact bond prices, but this also provides opportunities to reinvest at higher yields.

• Duration Management: One strategy to mitigate the impact of rising rates is to manage the duration of the bond portfolio. Shorter-duration bonds are less sensitive to interest rate changes and can be a prudent choice in a rising rate environment.
• Laddering Strategy: Another approach is the bond laddering strategy, where an investor spreads investments across bonds with different maturities. This way, as bonds mature, they can be reinvested at higher rates, providing a balance between yield and interest rate risk.

Current Economic Context: Why Fixed Income is Attractive Now

Following the extremely positive coalition agreements with a focus on more centrist polices and the coming together of parties that support the Constitution, the rule of law, and boosting economic growth, we look forward with tremendous hope that the country will begin to move forward meaningfully in the right direction. Over time, this translates into more inclusive economic growth, a more competitive currency, and lower interest rates. This should also pave the way for the SARB to begin cutting rates later this year.

Maximizing Wealth with Fixed Income: Key Benefits and Strategies

Our Sasfin BCI Flexible Income Fund, which tracks the interest rate cycle, is ideally positioned to offer investors extremely attractive double-digit returns over the next 12 months. On a conservative basis, we expect our fund to return between 12 and 15%. Surely an opportunity not to be missed!

Conclusion: Enhancing Your Portfolio with Fixed Income Investments

In light of the current economic environment and the potential for attractive returns, investors should seriously consider increasing their allocation to fixed income assets. These investments not only offer stability and income but also present significant growth potential in the South African context.

The Sasfin BCI Flexible Income Fund is strategically positioned to leverage the prevailing economic conditions. Increased yields and stable returns make fixed income investments a critical component of a balanced portfolio. The Sasfin BCI Flexible Income Fund stands out, promising substantial returns in a favourable economic climate.