South African bonds are attracting attention – given the low-interest environment and search for yield.

“There have been large inflows into multi-asset income funds over the past few years, but many people are talking about the relative high yields and attractiveness of investing South African government bonds,” says Marthinus van der Nest, head of Amplify Investment Partners.

Managers of the Amplify SCI* Strategic Income Fund, which is ideally positioned in this market, have continued to actively adapt their portfolio as markets moved from late-cycle last year to the turn of the cycle this year.

Erik Nel, chief investment officer of Terebinth Capital and portfolio manager of the Amplify SCI* Strategic Income Fund, said the fund has aggressively increased its inflation linkers and South African government bond positions in response to this change.

“As the cycle evolves, we have very aggressively increased our inflation linkers, from short inflation-linked bonds to them being our third biggest position.”

This increase has been driven by the trends emerging from the response of fiscal authorities and markets to the unprecedented economic crisis of 2020.

As Nel pointed out, historically, economic crises are driven by banking, currency or debt crises, but last year provided all three variations and a health crisis on top of that, making this “a crisis like no other”.

With a total cumulative GDP loss around the world, which was magnitudes of that of the financial crisis, there was also a policy response like no other.

“We have seen an unprecedented stimulus from the fiscal and monetary side – what seems to be a coerced agreement among central banks, both in developed and emerging markets, to communicate to markets they will do whatever it takes to continue to support the recovery,” Nel said.

For the moment, central banks and fiscal authorities are likely to keep their foot on the accelerator, with some massive levels of stimulus and some very experimental policies. On top of a $1.9-trillion stimulus, the US is considering another $3 -trillion with investments into the economy and a focus on the green economy.

But there will be consequences of stimulus measures in the longer term, including debt as a percentage of GDP spiralling out of control, with the cumulative amount of global debt of households and the financial and public sector approaching $400-trillion.

Inflationary pressures are high, and it is expected that central banks and fiscal authorities will “run economies hot”, Nel said. “Where authorities will underpin an economic recovery, they will be happier with more inflation than usual.” This gives some floor to risk assets.

Sitting in the midst of this rapidly evolving picture, the Amplify SCI* Strategic Income Fund does not position for a single outcome.

Nel and his team believe that the vaccine rollout and stimulus policies are underpinning confidence and rising inflation, while pent up demand and high cash levels provide a floor to asset prices, and improving economic conditions support corporate earnings and improved balance sheets.

While South Africa is receiving some benefit from global policy responses and renewed interest in emerging markets, its coronavirus strategy is “sub-optimal”, and excessively high debt levels are a constraint to material improvement in the rand or lower interest rates.

The fund’s current portfolio position has shifted to focus on high quality, almost cash-equivalent instruments, balanced by risk/alpha investments, with a good split between the government and inflation-linked bonds.

Nel warns, however, that South Africa is at a crossroads. It has within its grasp the means to move the economy to a higher inclusive plain by making the right decisions, stepping away from market-unfriendly behaviour and decisions, embracing capitalism, and working on policy prudence and strong institutions.

“If we get these right, we will move into a positive feedback loop”, he said, which will see sentiment improve, fixed investment rise, the private sector support the economy, and foreigners come back into the market. There will be a lower cost of funding the economy, the excessive risk premium will reduce, the country’s credit rating will start to improve, and outflows in bonds and equities may reverse.

From a fiscal perspective, on the revenue side, inflation in commodity prices has resulted in profits for mining companies and increased tax revenue from them. “What we do not want to see is a situation where these gains are wasted by paying inflated public sector wages rather than invest in the productive side of the economy,” Nel said, adding that expenditure growth is “on an unsustainable path”, and the burden of proof lies with the government to show it can stop expenditure from rising exponentially.

Currently, markets are “racing quite rapidly up the curve”, although risks are high. The biggest risk has shifted from a renewed shock to the system from the virus to the risk of fiscal stimulus being removed too quickly.

In an environment with so many rapidly moving parts, active managers need to be ready to quickly identify changes and be agile enough to adjust to them.

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