Page 178 - Profiles's Unit Trusts & Collective Investments - September 2024

CHAPTER 9

Please comment on the year ahead and, if possible, estimate the performance of your fund
over 2 or 3 years. What are your targets and objectives for the year ahead?
The performance of the fund depends on three factors: the performance of global bonds in
general, our asset mix in terms of the fund’s exposure to duration, credit and inflation-linked
bonds and how these will perform on a relative basis, and the performance of the rand. Overall, the
global bond market (as well as the different sectors of the bond market) will be influenced by
inflation, policy and economic growth expectations. Internationally, the odds of a real recession are
seen as low at present. The Eurozone is struggling to escape stagnation, but given what has already
happened, the downside from here appears limited. The US still looks to be on track for a soft
landing. We therefore do not expect a big market rotation out of equities into bonds. The main
driver will thus be the policy direction, which will depend on where inflation is headed and where
central banks see neutral interest rates. Interest rates are expected to settle at 2.5% in the
euro-zone (3.75% now) and 3.5% in the US (5.25% now) after this cutting cycle ends next year,
and drift up again longer term.
Although lower policy rates should boost bond prices, with so many moving parts and
unknowns, forming expectations about the future return from a global bond fund for South
African investors is unrealistic, especially as some of the forces may offset, and others compound
each other.
Investors should view our bond fund as a source of diversification, a counterweight to offshore
equities in the context of a balanced portfolio, rather than as a bet on a particular economic
outcome.
Offshore investments are heavily influenced by the rand. Please give your view on the rand
over the next 1, 3 and 5 years.
The one certainty we have about the rand’s value in dollars is that it will fluctuate with the daily
news flow, much more so than hard currencies. Especially over the short-term, the exchange rate
ebbs and flow according to interest rate expectations (local and overseas), risk-on/risk-off trading,
emerging market sentiment, the commodity cycle and developments in China. It also reacts to
local economic and political developments, and significant changes in the country’s fiscal outlook.
With so many factors in play, it is impossible to reliably predict where the rand will be in 12
months’ time.
Nevertheless, the currency has been less volatile since the formation of the GNU and the
suspension of load-shedding. If anything, it wants to strengthen, albeit from the quite oversold
position ahead of the elections. The mood in, and towards South Africa has shifted; the rand’s risk
premium (and down-side volatility) related to political risk, structural challenges, the fiscal
outlook, and diplomatic tensions has narrowed. Investors’ focus is shifting back to the macro
fundamentals such as inflation, policy rates and growth prospects. If the positive mood translates
into positive economic outcomes, the rand will likely hold its value, or even strengthen some more
over the next 12 months.
From a purchasing power perspective, the rand’s fair value probably is closer to R/$16. In other
words, it still looks undervalued, but less so than a few months ago (by around 12%, based on a
long-term linear regression). Provided we follow through on the promising start to the GNU, and
address our structural constraints, there is a case to be made that the rand will still trade at
current, or stronger levels in three years, more so if global growth accelerates and China can revive
its property market. Longer-term, the rand tends to weaken according to the long-term interest
rate differentials between South Africa and developed markets. Based on the current differential in
10-year government bond yields, the implied depreciation of the rand to the US dollar is still
around 5% to 6% per annum over the next 10 years.
Please give your views regarding interest rate trends and the yield curve over the next 1 to 2
years. What interest rates can investors expect?
We expect interest rates to come down over the next two years, as inflation settles at a lower
level, and policy makers’ focus shifts back to stimulating economic growth. We don’t expect to
return to the zero or even low interest rates in developed markets seen over the last decade however.
Barring another financial or economic crises, interest rates in the US and Europe are expected to
come down by no more than 125-150bp. The SARB is unlikely to cut by more than that.

176 Profile’s Unit Trusts & Collective Investments — Understanding Unit Trusts