Current context
Fixed income markets started the period with a continuation of the positive sentiment we saw in the final quarter of 2020, but faced a difficult and volatile ending to the first quarter of 2021. Local fixed-rate and inflation-linked bond yields continued to benefit from inflows into emerging market bonds during the months of January and February. Higher expected global growth following on vaccine rollouts and the opening of economies, maintained expectations of higher global inflation (at more normalised levels). Locally, the fiscus received a much needed positive growth surprise in the fourth quarter of 2020, marginally closing the year-on-year GDP contraction for 2020. This spurred positive sentiment, but most importantly, implied that National Treasury was under less pressure to borrow through the issuance of additional bonds into the local fixed income market. Towards mid-February, the 10-year bond yield reached its lowest level in a year at 8.5%.

The second half of the quarter, however, saw a swift change in global sentiment. Markets began to fear that higher than expected growth, significant fiscal stimulus and accommodative global monetary policy would lead to the risk of soaring inflation. Inflation by its nature is one of the biggest risks to fixed-rate bond returns, eroding value over time. The result was that the US 10-year bond yield rose sharply to reflect the expected higher issuance and inflation expectations (which rose from 0.79% in December 2020 to 1.7% at quarter end) in the US. US breakeven rates (the market-implied inflation rate) rose above the Federal Reserve’s long-term target of 2%. The 10-year South African government bond followed suit as global bond yields rose in sync, yielding 9.5% at the end of March and reversing earlier gains. The February budget was considered relatively growth positive, however, as in 2020, the global backdrop was overwhelmingly difficult for SA bond investors. The result was a negative -1.74% return for the Albi for the period. Conversely, as fears of inflation rose, South African inflation-linked bonds had a strong performance, delivering roughly 4.5% for the period. Cash returned 0.9% for quarter, reflecting the low rate environment.

Our perspective

Entering 2021, money market rates were at historically low levels and, as we noted at the time, the "steepness" (the compensation for taking additional term risk) of the NCD curve was showing early signs of starting to return. Over the course of the quarter, we’ve seen this steepness normalise to more moderate levels. It’s for this reason that we have, in certain areas of the curve, taken advantage of this by buying NCDs. We are still mindful that there is room for this steepness to increase even further, while the potential for rate hikes as inflation normalises from very low levels remains a risk consideration, as we would prefer more attractive entry levels. As such, we remain conservative in our NCD allocation for now and continue to hold significant levels of cash, prioritising liquidity. This quarter has seen the Treasury Bill curve continue to offer attractive yields compared to the NCD curve, at lower levels of credit risk. And in certain areas the additional compensation has been at all-time highs. As such we have opted to increase exposure to Treasury bills at these points over the course of the quarter. Overall, the fund performance has been reflective of the low rate environment that has dominated the over the last year. As communicated before, the fund should outperform cash accounts over the near-term, as well as offer diversification against any individual bank risk.

Portfolio performance and positioning

Over the quarter, the PSG Money Market Fund returned 0.81% versus the benchmark return of 0.88%. The fund is suitable for investors who need an interim investment vehicle or 'parking bay' for surplus money with high liquidity and capital preservation requirements. The latter were key objectives for us during the past year.

The fund’s exposure to bank NCDs has increased from the previous quarter. This is due to the fund taking advantage of the more moderate steepness in the NCD curve. The fund has increased exposure to Treasury bills as the yield pick-up compared to NCDs has increased, while it also helps to maintain adequate levels of liquidity and improve credit quality. The fund still has higher levels of cash holdings in keeping with the preference for cash in the current low-rate environment.