Our bond market is a good prospect for investors and a reliable, safe and consistent vehicle to continue developing the country’s financial market. (Flickr)
When purchasing a new vehicle, consumers look to invest in a mode of transport that is reliable, consistent and safe. While different brands and body types might influence your preference, we are always compelled to consider reliability, consistency and safety as key deciding factors in our vehicle purchases – regardless of who you are and what you like.
In terms of reliability, we generally aim to seek out a mode of transport that won’t give us headaches. Consistency relates to our desire to find a vehicle that will perform reliably over an extended period of time, in any given environment. Bonus points are awarded to models which have a proven track record of overcoming South Africa’s potholes, dark streets, mountains, mud and madness.
With regard to safety, we seek to purchase a car that has transparently passed every safety test in the book. We hope the vehicle we are purchasing will not damage us – as the mode of transport responsible for the safe passage of those we hold dearest to our hearts. Safety ratings and guarantees will underpin our decision-making to a large degree – no one wants to invest in a vehicle that might put your greatest assets at risk.
When it comes to financial investments, similar principles tend to be applied. There are certainly no safety guarantees afforded to investors in South Africa’s financial markets, much like the fact that most vehicles are not bulletproof and are only able to guarantee your safety to a certain degree. But what investment advisers can do is find the investments that offer state-of-the-art airbags, with world-class braking systems and an ability to absorb impact unlike anything else on the market.
Thankfully, South Africa continues to have a thriving primary and secondary government debt market, despite our sluggish long-term growth forecast, infrastructure challenges and growing public debt. This is reflected by the country’s strong macroeconomic management and deep capital markets.
An investment vehicle that local and international investors should consider towards the stable generation and preservation of their wealth might well lie in the South African bond market – which has reached yields as high as 12% in the last two years, while outperforming those of other emerging bond markets (including those of China, Indonesia, Brazil, India and Mexico).
Some would be pleasantly surprised by the fact that our bond market became a global pacesetter last year, with a total return of 8.7% in 2021. In this sense, South Africa’s bond market was able to compete against and outperform those of some of the world’s most developed economies, including that of Japan.
At present, the United States 10-year Treasury bond real yield is -4.816%. The real yield represents the annual yield of the bond (3.447%) below the current US CPI inflation rate (8.263%). These figures indicate that investors are actually losing 4.816% on this investment, after adjusting for inflation.
Alternatively, the South African 10-year government bond real yield is 2.535% (while the annual yield is 10.335% below the CPI inflation rate of 7.8%), indicating that that the South African 10-year government bond is currently yielding, on a real yield basis, 7.351% above that of the US Treasury.
This comparison helps illustrate that, at present, South African bonds are stable investments, probably a result of the fact that the rand has remained shielded from the more debilitating effects of a global economy in crisis. Our bond market remains an attractive opportunity for investors and shows great promise as a reliable, safe and consistent vehicle to continue developing South Africa’s financial market in a globally competitive arena.
That said, when it comes to bond fund investments, transparency might be a critical “safety” factor that pre-determines an investor’s interest and commitment. In this regard, investors would be well positioned to select a fund manager who openly makes use of a quantitative investment strategy that is back-tested against up-to-date empirical bond data, in order to hedge investments against bond price movements, interest rate sensitivity and overall market volatility.
Investors should also mitigate against investing in funds that hide real returns through a special purpose vehicle (SPV) which is often created with a return horizon. SPV’s will characteristically pay back a percentage of interest to the fund that is unrealised. Once the investment horizon is over, investors often realise they have been misguided in their returns, and will either receive far less than what was originally conceived, or will have invested based on dubious performance reporting.
Transparency in terms of counterparty risk must also remain at the forefront of investors’ decision-making, with many recent scandals exposing great losses and theft in crypto funds specifically. Seeking out a fund manager who commits to holding client funds in a well-capitalised, respected custodian or third party can help mitigate against such risks and catastrophes.
Most seasoned investors with a successful line of investments will also confirm that the preservation and generation of wealth through low-risk, consistent and reliable investments will magnify down the line. Mathematically, this translates to thinking in terms of geometric averages (where events are multiplied together) as opposed to the ubiquitous arithmetic average (where the average is based on a sum of the numbers).
For this reason, allocating large components of a portfolio to investments that manage downside risk and offer steady upside returns has a profound effect over a relatively small period of time. Here’s a thought experiment – if you had R20-million and were given a proposal to turn that R20-million into R200-million – for calling heads or tails at the flick of a coin – would you take that bet? If you’re wrong, you’d lose it all. What would your judgement call be? The answer is that you should rather choose to steadily compound the R20-million!
Successful investors realise that wealth management is about this geometric average and that the utility of money tapers off, making sensible investing down to achieving a high probability “good” result. Remaining principally engaged on low-risk, consistent and reliable investments, which offer steady upside returns with a strong focus on risk management, transparency and downside protection, can offer you more in the long run than the flick of a coin today.
One thing is certain – South Africa’s bond market plays an integral role in supporting the stability and development of our country’s financial market, as an emerging economy with the most attractive (comparative) risk profile for bond market investments worldwide – let’s start capitalising on that.
Michael de la Hunt is the co-founder of Ion Capital Partners
The views expressed are those of the author and do not necessarily reflect the official policy or position of the Mail & Guardian.