Speaker 0:
this programme has been created, so you can put your questions directly to the experts. This is in the hot seat.

Speaker 0:
Welcome to us at TV s in the hot seat Fixed income with me, Joanne Banham. Today I'm joined by JP, portfolio manager at Methodical Investment Management. Albert, But head of fixed income Ashburton Investments. I'm Philip Bradford s a head of investments portfolio metrics. Welcome to you all, uh, fixed income. I'll, I'll be a confess. One of my favourite topics. I think it really sets the scene for global macro.

Speaker 0:
So, JP, I'm gonna kick off with you.

Speaker 0:
We're still talking about inflation. Sort of two years hence, what's happening to the inflation picture in the US today? And how does that speak to global markets?

Speaker 1:
Well, that's the trillion dollar question, I think. And I'm not sure that there's, um, 100% clarity on what we what we are going to see. I think we've seen, um, generally headline inflation coming down, um, core a little bit less less so,

Speaker 1:
um, and what's making the environment uncertain is that central banks are really quite conservative in terms of their the way that they look at the world, and they'll need to see those inflation numbers come down to levels that they their targets for the for the various central banks in order to feel comfortable that that they've got it under control. We obviously have been through a period of great differences in policy and inflation.

Speaker 1:
Uh, inflation has turned out to be stickier than than most people. The transitory, um, narrative has completely disappeared. Uh, it's turned out to be stickier than people thought. Broad consensus market consensus seems to be that, you know, we've kind of peaked in inflation. But the next question is,

Speaker 1:
does that mean we're getting back down to, uh, the inflation targets, Let's say 2% for the Fed? Or does that mean that inflation continues to be slightly higher than than they would like? Um, and that interest rates need to be higher than the market thinks they should. So

Speaker 0:
that trillion dollar question Albert, we've had some very strong labour data after the States recently. We've also had declining productivity numbers, rising unit labour costs. If you're the Fed looking at this at the moment, what are you thinking?

Speaker 0:
Um,

Speaker 0:
well,

Speaker 0:
I think it's a the difficulty with with trying to trying to get to what the Fed is thinking is that I'm not entirely sure that

Speaker 0:
that the what they say at various media statements is actually a reflection of what they think or what they want to mark the market. To think is they think right, because it's it really is like quite frankly, it's a it's a game of double bluff. I know that you know that I know that we we don't necessarily agree. But do I know that? You know that I know that you know that I know that we don't disagree backward, right?

Speaker 0:
So So I think I think the Fed looks at this and they and they say, Well, there's, um

Speaker 0:
I

Speaker 0:
I think that that at the moment they would prefer to see strong, stronger labour data in a in when inflation is falling Um, because the the converse is there is their nightmare scenario right where inflation remains high and you start to see a recession, right? So the longer that they can see strong economic data with inflation still trending down,

Speaker 0:
I think the more comfortable they would be the most. Obviously the ideal scenario is quickly falling inflation, right? But that seems unlikely given the scenario that they've painted themselves into um so I think that I'm not think they're not quite happy with the situation that they find themselves in. But I feel they're at least somewhat satisfied. And I think that looking at everything from M two to to what I suppose going to be in the next couple of months falling shelter prices,

Speaker 0:
I think I think they're OK with where they find themselves. If you look at their statements, they they they don't seem to be as aggressively signalling a lot of further hikes. So I think they

Speaker 0:
I think they're at least somewhat comfortable. But, um, trying to second guess them is is very challenging, I suppose. OK, so Philip, let's say we can't second guess the Fed, but we can look at the bond market OK and the bond market is giving us some interesting signals and I'm probably wrong on this. But it looks like the bond markets pricing in six rate cuts between now and next year. Sometime and yet we've got the Fed saying we're on pause, but we're not cutting. What do you make of this.

Speaker 0:
Yeah. So the bonds are obviously very forward looking. Uh, Whether you go two years out or 20 years out, they obviously are getting us back to what we would consider a more normal probably, uh, in terms of what we consider the average interest rate,

Speaker 0:
uh, around sort of 2.5 or so. And that is probably the reasonable expectation of of where we need to to get to. The problem we've got, though, is that that means that the market has factored in that level. So if it doesn't come down as quickly as expected, that's very dangerous for us as investors, because we're not investing in inflation. At the end of the day, we're trying to decide. Are bonds pricing the inflation scenario correctly? And And I think the the biggest risk we've got right now is that the Fed in particular, is forced to keep interest rates higher

Speaker 0:
because the economy is better than expected and and that, actually in itself is likely to seriously hurt the economy. So I think what we need to watch out for here. For me, the dangerous situation is if the if the Fed keeps interest rates too high for too long. So it's not so much the level or where it gets down to. It's how long they keep them high for. And that actually puts, puts a lid on the economy and effectively

Speaker 0:
puts the fire out. So and that is a big risk to us in emerging markets as well, because that's what paints back to us. So it's always about us as investors trying to look through to the next level and say, Well, what's actually in the price? But right now, as you've pointed out, is the risk is I think, that rates don't come down as quickly as expected and that that can be bad for quite a few asset classes, not just bond.

Speaker 0:
OK, so remember valuation point short term bonds. But JP if you look at the valuation of global bonds or US bonds in particular to Philip's Point, do you think they're pricing in too much too many rate cuts? I mean, would you be buy of those assets? And what do you think? The valuations of US Treasuries?

Speaker 1:
OK, so it depends. It's a it's a it's a big curve. So, um,

Speaker 1:
I wouldn't be a buyer of the two year because I think it is. I think it is currently too aggressive.

Speaker 1:
One has to remember that it's not just about people's expectations about what inflation interest rates are going to do, but also what they're doing with their cash. So if you're fearful about markets more broadly and at a point in time, the two year was up at 6% and you haven't seen those rates in 15 years, then you know that looks attractive. You could argue now they've gone too far, too far the other way. Longer term, the longer term Treasury, I think, is a more difficult call because,

Speaker 1:
you know, if we are in a situation and again, it's it's incredibly difficult to to see this, and I don't think I'm alone here. I think that the Federal Reserve is in this position as well to see whether this is going to be a landing and hard landing, a soft landing or, you know, no landing. And um, you know what that means for, you know, for for the inflation and future rates, my sense is that

Speaker 1:
longer term rates are going to be slightly higher than we've seen over the last since the global financial crisis the last 10 or so years. Um, and that's going to translate into, you know, aside from any kind of if we have a recession this year or next. Aside from that, a much longer term view we're probably in a higher, higher rate, real rate environment, and inflation is also probably likely to be slightly higher for for, you know, for a number of reasons. So,

Speaker 1:
um, you know, I don't think it's a screaming buy at 3 40 on the US 10 year. Um, but if you do that, you really got to be quite convinced that we are going to be hitting some form of slowdown or that, you know, um, the other thing to just to go back to the Fed as fixed income people. We like to talk about central banks, but it's important that people understand that the Fed doesn't do what what you think they should do. They do what they are mandated to do, so they have a mandate,

Speaker 1:
and they have to. They have to fulfil this mandate. It's not like they're not trying to necessarily micromanage the economy. They are they're trying to fulfil their mandate, which is employment and probably most importantly, inflation. So they do need to keep rates. They would rather err on the side of having rates slightly higher for a bit longer until they're 100% convinced that we we're in a landing of some sort and inflation is really under control.

Speaker 0:
And I normally stick to global for quite a while. But you've just brought in something that's quite interesting. You gotta, you know, play the cards you're dealt kind of argument. So, Albert, in South Africa today, we have absolutely no growth from what I can see, And yet we have a central bank. Seems hell bent on destroying inflation. What do you think That what do you make of the central bank at the moment in Africa? And what do you think they'll do here? What do you think the will do with rates?

Speaker 0:
So

Speaker 0:
I think the sob is it's unfortunately stuck between a rock and a hard place, right? The reality is that, um, as much as in as in high interest rates hurt growth. Um, high and runaway inflation hurts the poor more than higher rates do. Um, I also think that with the with the somewhat surprising rise in inflation locally, and your next point is going to be yes, but it's supply side inflation. It's not demand side inflation, and you're correct.

Speaker 0:
But you still have to try and manage it, or at least create the expectation that you're on top of it. Because they manage two things primarily right, uh, inflation and the expectations around inflation. And and at the moment they're trying to keep that down. And then, lastly, they are somewhat forced to hike rates due to the actions of the Fed.

Speaker 0:
So if the Fed is now effectively, like many people believe done,

Speaker 0:
hopefully we can. We can, um, keep the, uh, interest rates in South Africa on hold as well the advantage that many of these reserve banks should have. If near term inflation expectations are correct and when inflation expectations, I mean inflation forecasts is that their rate hikes or their rates will become progressively more hawkish as inflation starts falling and their real rates effectively keep on rising,

Speaker 0:
which means that if inflation keeps on falling, they might start. And I I agree with you, I don't think 400 basis points of cuts are on the card cards outside a major crisis. But they may start trimming rates if they if we're fortunate.

Speaker 0:
Um, but I think for now at least, hopefully no further hikes from the Fed, which should mean no further hikes in S A. Can I just add to that? And I think the

Speaker 0:
the central banks and so the the A is one and the the Fed is another. It's not actually inflation that they they targeting. It's monetary stability

Speaker 0:
is the one is the one key thing. And and it's important to understand that in the South African context, that's a lot about managing the currency as well as as inflation. So if you've got stable, stable, inflation, stable money, then then then people can do business, people can transact. If you've got the If, if you decide oh, well, we're not gonna hike interest rate and in and the currency blows out. That's actually far more of a risk to the economy than anything else. So I think in South Africa,

Speaker 0:
you know, let's be honest. The raising interest rates are not hurting the poor as much because they can't afford to borrow money as much it doesn't actually on the margin affect them. It really affects your middle class workers with people with jobs, people with home loans more than it's gonna impact those particularly on a margin. So I I think at a at a central bank level, it's important to understand that the S A B needs to keep interest rates in equilibrium with other countries around the world. So if they're ahead of the curve and they just keep the the short term rates

Speaker 0:
higher, it just keeps that balance in our favour. And I think that's why we're also happy. I think that the S A B has raised interest rates as proactively as as they have as other emerging markets have, because it gives us scope then to maybe cut sooner further down the line. So I think the S A B might hasn't done as much damage as people would think, because if they hadn't have done that, the currency could be much, much weaker. Right now.

Speaker 0:
I remember when the SAB raised rates, the currency strengthened for all of about 10 minutes and then reversed most of those gains. If you speak to global bond managers on EMS. They tell you they don't like to invest in countries with very high interest rates if it kills growth, because when they buy an emerging market, they're buying growth. I worry sometimes with this argument we have that Let's protect the currency,

Speaker 0:
but we're going to destroy the economy. I mean, it's all very well to say the poor don't pay interest rates, but they are employed by people who are paying interest rates. So I don't know. It's a really tricky one. I mean, I get you guys say the is great and it's controlling things, and they have. They're one of the best central banks around,

Speaker 0:
but let's just talk about inflation quickly. JP. Because I want to take on what Albert just talked about. He said, You know, inflation. Surprised? Surely, with load shedding, it's not a surprise. You you have pick and pay results coming out. Shop right results, talking about the amount of money they're having to spend just to keep the lights on. Excuse the pun. So

Speaker 0:
what's your So let's talk about inflation now, because that's what you guys are here for. Let's talk about s a inflation. What's your

Speaker 1:
take? Yes, So I think a lot of the inflation that we've seen is as a result of capacity reduction in the economy. So when you have load shedding, it means that there's less available capacity in an economy, and that is inflationary. So you can have an economy completely on its knees

Speaker 1:
and have huge amounts of inflation. If you if the economy is actually going, the capacity of the economy is going backwards. And that's what we've seen in South Africa, with load shedding and the costs associated with normal business, as you mentioned retailers or farmers or whatever it happens to be, so all of that feeds feeds through to inflation.

Speaker 1:
I I have a lot of sympathy for the argument that the so shouldn't be raising rates in in what is a tough economy. But if you look at the converse of that, for example, in the in Turkey, where they decided that they would try a different approach and and and actually cut rates in the face of inflation, they had run away currency declines, runaway inflation, their credit spreads were very wide. They became

Speaker 1:
you. You you can't take that argument too far because you end up, you could end up with a completely uninvestigated economy. So it's painful. Um, the is very much aware of the position that they're in and that what they're doing is, um, you know, is hurting a a really tough economy, but they've kind of got to do it in order to, you know, to keep things, um, you know, running sensibly and the currency under control.

Speaker 1:
So yeah, that's that's kind of where we are. OK,

Speaker 0:
so you inflation load shedding lack of capacity in the system. Albert, if we take the so then and let's pretend I agree with you guys, the so is doing a great job. OK, so so is keeping inflation expectations under control. Inflation keeps rising here through outside the sob control, effectively outside the economy's control. Does that mean the sob keeps raising rates?

Speaker 0:
So

Speaker 0:
it is it It's a challenging question. Um,

Speaker 0:
I think if we look at if you look at the situation that we've just seen in, um

Speaker 0:
um in, in in Europe and a couple of other countries, I mean, we have to We've got to remember that in the UK, we saw inflation in the double digits from a country that hasn't had inflation above two in years.

Speaker 0:
Um,

Speaker 0:
and if you look at the the US as well, they seen the highest inflation numbers that they've seen.

Speaker 0:
Um, the

Speaker 0:
I think it's I I don't think it's a situation that we will find ourselves in similar to, let's say, the the late nineties or in the in the U in the US

Speaker 0:
uh, during the oil crisis, where rates go to 15 2025% kind of numbers. I think it's a I think the Reserve Bank policy has has, let's say, evolved since then, and it probably has more to do with, um,

Speaker 0:
the perception that you've got at least some handle on it. Um,

Speaker 0:
I I think fortunately for the situation we find ourselves in at the moment, it's un. It's unlikely that inflation in South Africa keeps rising from here. It might be that inflation doesn't fall as fast as people think, but we are certainly on a downward trajectory. It might just be the case that it takes us

Speaker 0:
a year and a half to get to 4.5, whereas many people had 4.5 pencilled in for the end of this year.

Speaker 0:
OK, so we get there, it just takes us a bit longer.

Speaker 0:
But back to the question. I'm gonna ask Philip this question. Do you think the Because we know the well Supposedly the Fed is pausing OK, and the Fed is going to watch to see what happens. Do you think the sob pauses for a while and and to to Albert's point, it's going to come down? It's going to take a bit longer. So do you think the pauses Well, we don't know if the Fed is going well. We think everyone's guessing. No, fair enough. Assuming they Yeah, so I don't think the sob can pause until we we know the Fed actually has paused. So but exactly that I think we need to be one step ahead of them.

Speaker 0:
Uh, and we need to Sabre rattle, and we and the the SAB needs to to absolutely leave it with no doubt to foreign investors that that our Reserve Bank has got things under control and they'll do what's required to to keep stability. And that would That's why actually you might you might have seen the currency

Speaker 0:
a little bit when when we had, uh, more rates than expected. The bonds actually rallied more than that at the time. So you saw the long end of the the yield curve. And this is such an important thing again is that we're talking about inflation over one year. Well, if I'm buying a 20 year bond, I need to know what inflation is going to be for 20 years. So I'm actually taking a much, much longer term view. So actually, what happens in the short term

Speaker 0:
is isn't as important on a very long term, uh, relative, uh, evaluation view. But it does impact short term capital movements. So that's why we we're a lot more sensitive to it. But at the end of the day, I I think that until we start seeing rates going down

Speaker 0:
around the world, we're not going to be able to start cutting rates in South Africa. OK, so let's talk about the thing you just mentioned. There was 20 year bonds or 30 year bonds or long term bonds, where we're more worried about the economy perhaps than necessarily short term inflation fluctuations. So JP, my question to you is has come out and said, You're not covered if there's grid collapse, so big companies are not covered. We know insurance companies won't cover if there's good collapse as a bond investor. When you read that, given that you're lending for a very long term,

Speaker 0:
what do you think? Well,

Speaker 1:
obviously it's not good news. Um, and, uh, you know, it's obviously a concern. Uh, you know, I think the

Speaker 1:
the possibility of a of a grid collapse and, you know, load shedding has been a feature for for a while now, so none of this is

Speaker 1:
others, particularly new. I guess you could say that. You know, through that the consequences of it happening are greater.

Speaker 1:
I do think on the kind of, um, glass half full. I know it's an odd thing for a fixed income person to look at it this way, but, um, that we are seeing, we are seeing capacity come in from the private sector and in terms of, um, generation.

Speaker 1:
And, um,

Speaker 1:
I do think that we're probably, you know, 12, 18 months away from a less drastic point than we have now. I do know. I do know a transmissions expert who assures me that we will not have grid collapse. Um, OK, uh, but you know, and and that the the the Eskom engineers in the transmission unit, which remember, is a different unit to the generation are very much in control. But, you know, it is it is a scary, scary thing.

Speaker 1:
Uh, I think it's a great point that Philip made about investing for 20 years. I think the world is somewhat forgotten that we we you need to have a slightly longer. I mean, even Mohammed Al Erian came out and, you know, sort of chastised the Fed for being, you know, data dependent. Which means that you you're changing your view on, you know, 11 piece of data when you should be thinking about what are the kind of neutral real rates that we should be having in our economy.

Speaker 1:
And how do we set policy according to those we are all going to have? You know, we could all have a bad inflation number, a bad employment number. But you know, what's the what's the kind of general state of the economy and what kind of levels of interest rates and inflation should we be setting for the longer run. So again, if we come back to South Africa, you know, seven and three quarter inflation is at 7.1. It's not as if we've got, you know, Repo at 14 and inflation at four.

Speaker 1:
Um so if if we if we do see the cap and inflation continues to come off, then they have a space. When real rates, as Albert was talking about when that real rates to inflation gap becomes a bit larger, then they then they are in a position to cut rates. But it's still very tight. I mean, we are only marginally in real positive real rates Remember we've had in the past. And I would say the kind of neutral, long term real rate should be somewhere around two,

Speaker 1:
2.5 3. so we're still quite, um, accommodated from a long term, uh, real rate perspective. So you've got to kind of bear bear that all in mind and not get too reactionary to one to the one piece of one piece of information. OK, but let's

Speaker 0:
just stick with the sort of long term debt in South Africa. It gives you very juicy yields. OK, so Philip, you you often talk about. The juicy yields are on offer, and it's very exciting. But I listen to this and I go

Speaker 0:
We've got a country that's let's be honest. It appears to be imploding at the moment and a country that can't keep the lights on. And people are getting scared about grid collapse. And I hope you're right. I hope it's not going to happen. But these are very real things that are happening on our watch. How are you really that happy with yields where they are or you're saying is you know how. How do you think about this? Well, I think you know, we've been around this this market a long time and, um, you know, you go back to 2008, uh, interest repay rate was 12,

Speaker 0:
and bond yields are actually around 7.75. We've now got the repo rate at 7.75 and bond yields at 12. So we've always got to ask ourselves how much is in the price, and it's not so much about being positive. I I think it's about there's quite a big margin of safety, so you shouldn't have the repo rate at 7 75 and long rates at 12. If we've. If we're really not that negative on inflation,

Speaker 0:
there's an enormous gap there over the longer term. That's that's normally would be, uh, a situation where you've got strong inflation and growth, which we, we kind of agree we don't have demand driven growth. We've got this supply problem at the moment, and load shedding is an issue, but it could come out of the system. So I think we've always got to be pulling ourselves back as investors and and saying, Well, even if we are wrong,

Speaker 0:
that for me is important because it's not about guessing what US inflation is gonna be, it's gonna be in a negative scenario. What do we think s a Bonds will give us, and in a positive scenario, what do we think they'll give us? And I think the the yield is so high at the moment. Right now, it's It's some of the highest we've we've ever seen in our really. I mean, only 98 was probably where when interest where when the repo rate was, What is it? 22 a half, OK, were bond yields higher.

Speaker 0:
But but the point here is that I I think there's a margin of safety and good value investors speak of of holding some of those bonds at this stage. That they are higher than the gap over cash is wider, one of the widest we've ever seen. So there's there's as investors. We gotta take it to that next level and and I think that even in a bad here, I think we're still getting more than

Speaker 0:
compensated for the excess risk we risk we taking in the longer dated bonds. And importantly, that's not credit risk of Corporates that are the ones that are going to be the most hurt by grid failures and the like. That is government government exposure. It is like that for a reason. Of course, there's a reason yields are high.

Speaker 0:
Uh, if it was, if there were no risks out there and we were getting 12, I think everyone would only we would we would make a very interesting argument about not buying equities. Yeah, but But again, if we go down the grid failure kind of route and all of that well, I I I would be very very cautious of any equities in South Africa. I'd probably still be OK in those bonds, Believe it or not, at 12, um, I I might see a bit of capital movement, but, um, I'm I've still got an income of 12. Where

Speaker 0:
your your your local companies that are based in South Africa, the shop rights, et cetera. Even the banks are like those are those aren't going to be doing very, very well in that environment. So I think the the the the as an asset allocator, the risk is skewed towards those bonds. The nice thing, though, is the yields are high enough. I think that you don't have to put all your chips in and and go into it. You can actually just add a bit of that that, uh, that longer dated yield to the portfolio. And I think that's likely to provide in an energy

Speaker 0:
sort of analogy, the base load kind of base load kind of return. It's a bit like nuclear. In a way. It's very stable until it isn't, um, but But the point is, I think that that that yield is high enough to to to just to compensate you for the additional volatility and risk. But I think there's also one thing I I would I'd like to add There is. South Africans tend to focus on our own issues. Right.

Speaker 0:
Um, if you think about Europe just in the last 24 24 36 months, they had covid, then they had lockdowns. Then they had a war with the nuclear power breaking out out next to them. Then they ran out of gas. Then they ran out of power. Then they shut down all the nuclear power plants and reverted all the way back to coal. Right? That's just Germany,

Speaker 0:
right? In London, they had inflation link. Bonds fall, inflation link. Government bonds fall 65% to 35 cents on the pound. Right. That's roughly three times the drop we saw on our S A equity markets during covid, right. Taiwan constantly lives under the fear of invasion by China. Japan has a shrinking population dynamic.

Speaker 0:
Uh, South Korea has shrinking population. They currently have 0.75 Children per woman in that country. Their population. Right.

Speaker 0:
Sorry.

Speaker 0:
The point is right. There's many countries have to deal with many issues, right? And and Philip's point on on finding the right price is the correct one. I I agree with you. There's a range of things I like holding South African fixed income at the moment. But I'll be frank and say I'm probably underweight duration, um, relative to where I was, say, a year or two ago and I'm holding slightly more cash and credit and short term instruments. It's a lot easier now that you're getting

Speaker 0:
almost 9% on credit, right in an in an inflation environment, that should trend towards four. Um, but there are other countries, and they all have their own issues. We just have to You have to price your own

Speaker 0:
part of that. Pricing is the rand, so you can have all these assets doing very nicely for the rand blows out. So we talked before on these calls about sort of global allocation within your fixed income portfolio. So JP just to talk about, you know, hedging out certain risks because I agree you have very high yields, but the rand might blow up because of it. Do you have any kind of US Treasuries that you're holding? Are you having anything that you're holding in your portfolio to mitigate the risks that we see within your own

Speaker 1:
portfolio. Yes. So I have I have

Speaker 1:
dollar exposure. Um,

Speaker 1:
great. It seemed, you know, like a no brainer when we ran was in the fifteens. Now it's in the eighteens, you know, maybe not so much of a no brainer. But obviously, we have all of the, you know, issues that we we we've talked about, but I like the way that it creates some buffer. If there is a significant negative, um, environment, we do seem to be sort of bouncing around these levels, so it feels like it's going to go in one direction or the other. We're just not quite sure Which which one?

Speaker 1:
Um, I've got some very short term, like, very short term Treasuries in the in the portfolio. Um, just because the yield is there and and I think the, um, the credit spreads are attractive, uh, for some of the South African names. So there is some South African spreads that are, um are attractive, but they've been wider, you know, October last year they were significantly wider. If I look at high yield as a kind of proxy or E m

Speaker 1:
credit spreads, they were significantly wider. So the market is relatively calm in the credit space relative to to what we've seen. So for me, it's more of a you know, there's probably going to be opportunities to pick up some of this credit if we see another bout of risk of which, you know, we we most likely to see because interest rates have been put up.

Speaker 1:
Liquidity is, you know, you can argue with the liquidity is coming out of the system, but, you know, it's certainly not the rosy environment. You've got a bank failing every 10 minutes, it seems in the US. So you know, not small banks, not small banks, large banks. Um, you know, and that's just the result of I mean, you could It's it's just a function of interest. Rates go up.

Speaker 1:
Um, and you know, the the the underperforming assets or underperforming companies just, you know, hit, hit the wall. We had a huge amount of zombie companies that were raising money at zero interest rates and surviving even though they never made a profit. Um, so a lot of that excess

Speaker 1:
you should come out of the out of the

Speaker 0:
economy. My question is more around, like promote diversification. Benefit. Are you seeing the diversification of benefits of having some dollar assets in a fixed income portfolio to mitigate the risks of a brand blowout? I mean, none of us get the rand call, right? I mean,

Speaker 0:
most people don't, OK, but But the thing is, is that something that makes sense to you from a portfolio construction perspective? Are you looking to add that just to balance out the risk? Yes, so that

Speaker 1:
I do do that as to balance out the risks. But I mean 11. Also, if I if I looked at a complete grid collapse environment and bonds went, you know, 10% you know, yields above where we are now,

Speaker 1:
your your your your five or 7% rand rand. Dollar exposure may not give you enough of a of a buffer, but it gives you some buffer to the kind of day to day volatility that we're seeing in them.

Speaker 0:
Yeah, I think from from my perspective, and and this is actually you know, again, it depends what portfolios we're managing, uh, and and for me, particularly in that that income type, flexible duration space. But even in the bond fund we manage is we don't hold any foreign assets any dollar based assets, but mainly because the investors that that use us are

Speaker 0:
discretionary managers, multi managers, professional investors as well as well. And in our own asset allocation, we we know that the protection sits elsewhere in the portfolio. So, really, we try to generate the best rand return possible. And the the challenge with buying a a dollar based asset is that that, yes, it can work in a in A in a selloff situation. But

Speaker 0:
can it can destroy you? Normally, slow burn hurts you as the rand strengthens as well. So and if you do go offshore, you're typically giving up a big part of that yield, less so in the shorter dated stuff at the moment. But in your longer dated yields, the yields are lower, so it's there's an opportunity cost, and I think, what what people have missed over time. If you go over the last 2030 40 years, it's very similar. The rand on a If you'd gone into dollar cash or or rand cash, the the devaluation is only about 4 to 4.5 4.5 to 5% a year,

Speaker 0:
and your interest rate differentials actually typically been higher than that. So it's actually been. Don't ignore the interest you get when you go offshore. If you go offshore and you're getting no interest, at least you're getting some $9. But a few years ago, it made no sense to me to do that. So it's really about saying, Well, what is gonna protect protect you and I I think in an environment where you're holding a bonds in our asset allocation, our multi asset portfolios, we did our big offshore switch last year. This time,

Speaker 0:
uh, the R 28 change happened, and we did a huge switch out of S A equities in the global equities and actually, at the same time we increased s a bonds

Speaker 0:
because we actually find they offset each other quite nicely. A bonds are a risk on asset. Yeah. No, I I get all that. I guess where I'm coming from is for clients who do want their fixed income managed to do the best they can within their fixed income portfolio. Does it make any sense if they don't, if they haven't matched it with global equity somewhere else in the So you're saying no. You're saying the way you guys run money

Speaker 0:
you stick to s a assets and you don't add global within your fixed income component. You do it outside that portfolio, find adding the dollar assets adds more uncertainty than than than than reducing it for me. And and the movements on the currency are are far more variable for me than than they are holding bonds.

Speaker 1:
If I can just jump in, I think an important point on this is that you know, I was talking about the income fund income investors. Their biggest enemy is inflation, and you know,

Speaker 1:
there's a couple of ways you can protect them. One is by having some dollar exposure. If if suddenly the central bank, the Reserve Bank, decides that we going, we going to slash rates. Even in the face of high inflation and the currency blows out, you at least have some dollars in the portfolio and then inflation bonds. So you need

Speaker 1:
that in the in the in the portfolio to protect the investors from a a big blowout in inflation.

Speaker 0:
Albert. Sorry, I need to get Albert to come in here because he normally you can't shut him up. But Albert, I mean, what what's what's your view on this? Because we got two sides of saying, Look, I think it's some

Speaker 0:
Well, it's it's a It's a brilliant argument to sit in the middle of right. Firstly, you're in the middle, quite literally, right, But it's it's also, it's also the difference between saying, What's the best portfolio? Is it this income portfolio, or is it this equity portfolio? It depends on what your clients want.

Speaker 0:
I sit with a lot of clients that want a low risk solution, right and very significantly fewer clients that use the income portion as part of a building block approach. Hence, my portfolio has dollars in it and some dollar assets, because I feel that's appropriate. And Phil has also argued that in a broader solution, you have some dollar assets. If you your client base primarily uses it as a building block approach with a range of other things, then no.

Speaker 0:
Now I think that the the question that that you asked JP earlier on diversification is I mean we know that dollars adds to diversification. Phil is entirely correct. It is a case that there is a cost to hedging, right? You can either hedge with options or you can hedge with asset classes. Neither one comes through. There is always a cost to hedging. Um, and I the The reason I

Speaker 0:
as personally like using dollar and dollar assets in the portfolio is it gives me more levers to pull right when what I mean by that is at the moment I'm sitting in the portfolio and thinking, OK, well, I like the bonds at 11,

Speaker 0:
but I think there's a lot of political risk we're going to see over the next nine months. And there's some growth concerns. And there's Eskom concerns. The electricity minister the other day intimated that we might run 12,000 megawatts short over winter at some point. So stage 12 load shedding potentially. Um, so So in that circumstance, I'm not sure I want to be overweight s a bar. So having offshore assets, frankly, I enjoy being able to go. OK, you know what?

Speaker 0:
Neutral a bonds for the moment. I am gonna buy some e m bonds and and and maybe some T bills and maybe some, uh, the developed market property looks cheap. I don't actually think that, but I'm just just using it as a point it gives me. But I guess what? Your creativity. But to answer your point, I mean, it thinks how it sits within a portfolio that somebody else is buying. So if somebody's buying a portfolio, they don't want to lose money. Say, in your portfolio you you're reducing the risk in your portfolio. They want an income solution so they don't want you to be playing with the rand.

Speaker 0:
Yeah, well, well, I also don't think it's a good idea, to be honest. So So, actually, last year is a a great example. So in for for like our income portfolio, we've probably got more bonds than any other income fund manager. I'm almost certain of that. OK, now, the irony was is we did 8% last year, So the environment where we had massive inflation shocks way more rate hikes than even we dreamed of,

Speaker 0:
and it was still fine. Now why was that was because, actually, what does also protect you when interest rates are going up are variable rates bonds, so they move up as well. The difference is you don't get the capital volatility there that you're gonna pick up by buying inflation links or buying currency assets. So that's actually been the the great sort of protection and then also just adding bonds into that weakness. So being able to beat cash and inflation and all of those by 23% last year in an environment that should have been bad for us tells

Speaker 0:
you the story that actually there are other assets to protect you rather than currency and rather than inflation link as well. Guys, we are kind of running out of time, and I just want to kind of wrap up here with your best portfolio ideas. So I must start with you on sort of a 12 month view. What's the part of the portfolio you feel most confident about and and why?

Speaker 1:
Well, I I I like your diversification question more because, uh, because I feel like at the moment the portfolio actually has a couple of you know, a couple of good ideas in there rather than one single, um, home run. I don't feel like there's particularly a home run in there at the moment because I think that the the the environment is uncertain.

Speaker 1:
So, yes, I've got some fixed rate bonds in there. You know, if inflation has peaked and interest rates have peaked and those are going to do well, I've got some short dated inflation link in there. If inflation continues to be sticky, they they will protect the fund. I have some dollars, which I love having in there much to discuss. You know, that will protect protect the fund. If, you know, we do have a,

Speaker 1:
um you know, not not saying it will protect the fund from the grid collapse, but, you know, if we do see, um, further eruptions. Uh, so it's the balance of all of those things. I think that, um that that fair enough?

Speaker 0:
OK, Albert. So, um, I think I mentioned it before they Morgan Stanley released a report that 2023 is going to be the year of yield. Um, now, uh, I broadly agree with P, but just so just so you can have another opinion as well, um,

Speaker 0:
South African investors are in a quite a fortunate position at the moment. that for most of them, right? I mean, we all deal with a lot of different clients, but almost all clients want somewhere in the C P I. Plus two to C Power plus four kind of range. It's the rare investor that's looking for the C Power Plus five and the C Power plus six,

Speaker 0:
Um, and quite honestly, to be at least somewhat controversial and boring, you could get almost to see powerless for just sitting in cash and credit, right? The markets at the moment are difficult, right? They're they're tough. Um, there. I think everyone on this stage would agree. There's a lot of uncertainty locally, There's a lot of uncertainty internationally, and you don't always have to participate at all times if you have a home loan at prime or prime minus one.

Speaker 0:
Put some money there. You don't even have to pay tax on the gains. Put your money in cash it it cash and credit. It gets you 9 9.5, almost 10% on some of these funds. It is a very, very nice return, very stable, very predictable, very liquid. And in six months, when Joe has it on again we can. We can argue about where to go from then. But for the next six months, get through the winter and see what this Africa is like in September.

Speaker 0:
But you're also being paid to wait, though to your point. You have got a very juicy yield while you sit and do nothing. Well, not saying you're doing nothing, but you could sit and do nothing and have a good year full point. Earlier on in the u, you had to pay to wait. You're earning 0%. Now you're earning 9% just to wait on the sidelines, which is not bad. Not bad. OK,

Speaker 0:
yeah. So I think our our positioning is a bit like Goldilocks. Not too hot, not too cold. So So. But But the point is here, there's it's like a barbell sort of approach. So from this time last year, we've actually doubled our bond exposure, particularly in the income fund. So we've gone from

Speaker 0:
sort of 18 20% bonds to now, like 44% bonds, mainly simply because they got a lot cheaper. Um, as simple as that, the yields were higher and it allowed us to to really lock in nice yields, but we don't need to hold too much, you know, to go more than that. So the car, let's say, can go 200 kilometres an hour. But we only need to go 100 kilometres an hour to get there safely on the other end. And if you start going to

Speaker 0:
fast you, you don't have room to pick up speed into into any kind of sell off. So I think those tail risks are still there. I think we're going fast enough. Uh, we we've still got a huge whack of the portfolio that's benefiting from interest rates going up. And if there are any selloffs, then we want powder dry to be able to go into that. So bottom line, we're sitting with a yield of over 11% at the moment and the income fund we're up to about 11.4% today

Speaker 0:
and that's that's a gross yield. Now that's very powerful because that means that all our sequel, that's your cash flow over the next over the next year. So it's it's that plus or minus, depending on what happens in the market, so I don't think you need to be too aggressive. I don't think you you're getting paid to to get enough yield. You know anything more than 10% is is what you expect from equity markets. So if you're getting a yield from bonds higher than that, then actually you, you, you, it It's a very nice situation to be in

Speaker 0:
very last question, because I know I shouldn't. But every panel have asked fixed income guys lately. They've told me Bonds a bit better than equities. You get equity like returns with bond like risk. Do you agree bonds better than equities? JP.

Speaker 1:
I mean, I know what Phil's answer is gonna be, but, um, it depends. You know,

Speaker 1:
It depends on what happens with inflation and growth, and it's not. It's not a it's not a one answer. Right now, the yields are attractive. In South Africa, there is a reason why the flows have been into income funds. The flows have been into bond funds because people see

Speaker 1:
the ability to get C P I plus four or five without taking significant risk and a very uncertain environment. If that all turns around, then equities could could do well, but you can park. You can park your cash in in, um, in short term bonds and even longer term bonds without taking the significant risk.

Speaker 0:
So fixed income for the win can I say bond managers are better?

Speaker 0:
No. So, um,

Speaker 0:
South Africa's equity returns has, I mean, we know has fallen, right? We spoke about growth earlier. Um, until we get the power situation right in South Africa, No, no country can grow without power.

Speaker 0:
Um, we may find ourselves sitting here again in end of 2024 we sitting on stage one or stage zero, load shedding for a lot of the time. And then South Africa may have massive pent up demand until we're there. Until we get to that point, I think you're gonna do better in fixed income than you're gonna do the outside specifically, without a doubt on a risk adjusted basis,

Speaker 0:
I I think maybe the better way of looking at it. If you've got an asset allocation currently and it's got exposure to S a equities s a bonds, global equities, et cetera, and and you've got some cash. I I think the the rational decision is rather to increase bonds rather than equities at this point. Because the risks that I think it will be bad for s a bonds will be far worse for for equities.

Speaker 0:
Gentlemen, thank you very much for your time today. I enjoyed it thoroughly. Thank you.