What’s the story for bonds?

By: Ian Scott, Head of Fixed Income, Momentum Investments

“Equities are boring and bonds are disgusting” – Jeremy Grantham

As fund managers we are continuously asked the following questions: When should I invest in bonds? How can retail investors allocate capital to an institutional market? Should I buy nominal bonds or inflation-linked bonds? And the list goes on.

As we work through these questions, we must start by saying that government bonds are medium to long term investment instruments, so before an investor allocates capital to bonds the investment horizon should be around three years and longer.

Bonds are not money market instruments to park cash in for a short period of time. Yes, nominal bonds are liquid to trade in and out of, but the capital volatility over the short term may create capital drawdowns. When investing in bonds investors need to be able to extract returns from both the income and capital components that bonds deliver, usually over a three-year time frame because that is how long an interest rate up-and-down cycle lasts.

So, when do you invest in bonds?

Textbooks will say the best time will be at the end of the rising inflation and interest rate cycle, with the market pricing for stable to falling interest rates over the following year or more.

I believe this is exactly where we are finding ourselves in the cycle. The global central banks have increased interest rates significantly over the last 18 months, and where all central banks were in full hiking mode last year, we are now starting to see divergence in global central bank policy stances. The US Fed is close to the end, if not at the end of its hiking cycle. The Bank of England and European Central Bank has to hike further. But we are starting to see policy easing in emerging markets like Chile, Brazil and China. Domestically we also believe the South African Reserve Bank has concluded their hiking cycle and will go into a hold mode before reducing the repo rate early next year. The main reasons being inflation falling into the target band and low economic growth. There is no reason to maintain restrictive interest rates for too long in such a macro environment. With the inflation and interest rate forecasts looking favourable, we believe this is an opportune time to allocate capital to bonds.

The second factor in the bond investment thesis would be valuation. Yes, there are so many negative news headlines every day, but we believe that a lot of that bad news is already reflected in the yield (price) of SA bonds. Inflation is expected to average 5.8% this year and 4.9% in 2024[1]. With the 10-year bond yield at 11%[2], that is a real yield of 6% over the next year or more. Bond yields in SA currently are in the valuation domain of equities, but at a lower risk (government credit rating in SA is AAA vs corporate credit ratings of equities). Secondly, the All Bond Index yield at 10.4%[3] looks far more attractive than the ALSI dividend yield of 4.7%[4], and for investors looking to generate income in their portfolios this must be appealing.

It’s hard to decide in which fixed income asset class to be invested in. If you believe nominal bonds is the place to be over the medium term an allocation to a bond fund would be the correct route to follow. For investors that are unsure, we would suggest investing in a more flexible bond or income fund product. In flexible products the investment manager has the ability to allocate capital to the various yield curves on their best investment views to the benefit of investors.

Momentum Investments has a range of local unit trusts and offshore unit trusts to choose from, including our fixed income range which includes the Momentum Bond Fund, the Momentum Flexible Income Fund, and the Momentum Income Plus Fund.

So, what do we make of British billionaire investor Jeremy Grantham saying that “bonds are disgusting”?

Yes, bond investing has been tough over the last year or more, but for valuation-based investors like us, it’s in times of high yields (low prices) and unloved asset classes that we are finding the best opportunities for generating future returns for our investors.

Speak to your Momentum investment consultant today to find out more about our fixed-income range of funds.

Momentum Collective Investments (RF) (Pty) Ltd (the “Manager”), registration number 1987/004287/07, is authorised in terms of the Collective Investment Schemes Control Act, No 45 of 2002 to administer Collective Investment Schemes (CIS) in Securities. The Manager is the manager of the Momentum Collective Investments Scheme. Standard Bank of South Africa Limited, registration number 1962/000738/06, is the trustee of the scheme. CIS’s are generally medium to long-term investments. The value of participatory interests may go down as well as up and past performance is not necessarily a guide to the future. The terms and conditions, a schedule of fees, charges and maximum commissions, and additional risks are available on the minimum disclosure document (MDD) and quarterly investor report (QIR) for each portfolio which is available on momentum.co.za.

Momentum Investments is part of Momentum Metropolitan Life Limited, an authorised financial services and registered credit provider (FSP 6406).

The information in this article is for general information purposes and not an invitation or solicitation to invest. The information is not intended to be accounting, tax, investment, legal or other professional advice or services as set out in the Financial Advisory and Intermediary Services Act 37 of 2002 (Fais), or otherwise. Financial advisers should conduct a suitability analysis and due diligence with clients on the investments mentioned in this article as part of their investment mandate and investment advice process. 

[1] Momentum Investments, August 2023

[2] Momentum Investments, August 2023

[3] Bloomberg, August 2023

[4] Momentum Collective Investments, August 2023

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