Bonds offer an attractive alternative to cash

By Gareth Bern, Head of Fixed Income at M&G Investments

Gareth Bern

Investors may be surprised to learn that South African nominal bonds have delivered healthy returns to investors prepared to brave the volatility over the last few years and that this impressive performance is likely to continue. With excellent returns of 12.4% over the past year and 8.9% p.a. over five years, for example (as shown in the graph), the FTSE/JSE All Bond Index has comfortably beaten cash returns and inflation by some margin.

Consider that during this time, investors have had to contend with the sovereign credit rating being downgraded to junk status and below, the increasingly high debt levels of the National Fiscus, the impact of Covid-19 on ‘SA Inc’, the July 2021 riots, and who could forget load shedding!

Given this backdrop, one could be forgiven for assuming that bonds would have been a poor investment choice, but instead, the opposite has been true. And why? Largely because of the local market’s exceptional cheapness, offering very attractive yields versus other sovereign debt and, more recently, improving local fundamentals.

And despite the healthy returns they’ve already delivered, we still believe the prospective returns available in the domestic bond market look compelling. With 10-year yields still close to 10% and longer-term inflation expectations well contained thanks to the South African Reserve Bank’s efforts, investors are looking at a prospective real return which should be well above 5.0% p.a. – a very attractive return package, particularly when faced with a cash return which will struggle to beat inflation. Based on current valuations, we expect nominal bonds to outperform not only cash, but also SA inflation-linked bonds, SA corporate bonds and global bonds over the medium term.

Even though corporate bond valuations are currently attractive compared to their longer-term history, we are holding less exposure to these assets than in the past. This is because they come with higher risk than government bonds, but offer lower yields and lower return potential.

This impressive performance, as well as the attractive prospective returns, have not gone unnoticed by investors. ASISA industry statistics indicate a marked shift into bond funds through 2020 and much of 2021. Equally, asset managers have shifted their fund positioning from cash into bonds: in the ASISA Multi-Asset Income category the average fund’s bond weighting rose by 6% between 2019 and 2021 at the expense of cash.  

At M&G Investments we are overweight SA bonds in our multi-asset portfolios compared to other fixed-income assets, and are convinced that this remains the best positioning for lower-risk investors. Those who may have invested more of their portfolio holdings into cash over the past five years, or even more recently, may want to reconsider that bonds are likely to offer much higher return potential going forward.

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