Have interest rates peaked? A dilemma for fixed income investors
By James Turp, Portfolio Manager, Fixed Income
Fixed Income investors are enjoying investment returns above inflation after a rapid 4.75% nominal increase in domestic interest rates over the past two years. Now investors are asking whether this is the right time to put their money on fixed deposit to take advantage of these higher rates.
The answer is not simple, since all investment decisions incur consequences that add or subtract from returns. Even though inflation appears to be stabilising, other concerns should make investors cautious, at least for the next few months.
In November 2021, the South African Reserve Bank (SARB) embarked on a policy of interest rate hikes to contain anticipated rising inflation and return rates to a neutral level for economic growth. Consumer Price Inflation has returned to the target range of 3% to 6% and is expected to remain within this range, the repo rate has also been held at 8.25% since May 2023. Two years ago, it was 3.5% and investors were not yielding real returns, whereas now short-term rates are above current inflation. The market continues to forecast the possibility of a slightly higher repo rate over the next few months.
Using the repo rate of 8.25% as a starting point, investors should aim for an annual investment return that exceeds this. On 31 October a one-year fixed deposit rate is 9.15%, rewarding investors for locking up their funds for a year. This one-year deposit seems like the simple decision to make, or does it?
Liquidity should not be taken for granted and having access to funds in the current economy should be taken seriously. This is where unit trust investments can be compelling. By combining multiple investors into a fund with a defined strategy, a unit trust has a good chance of providing an investor significantly better returns than could be achieved independently, while providing a level of liquidity similar to cash.
Depending on an investor’s view on the path of rates from here, an appropriate unit trust can be selected. If an investor is unsure, a low risk unit trust could be considered.
In the Sanlam Fixed Income Unit Trust Range, funds are defined by their effective interest rate risk. A call deposit, for example, has one day of interest rate risk, as it will float and adjust higher if rates move up, or downwards if rates are cut. A one-year deposit has 365 days of interest rate risk on the day of purchase. If rates were to move higher the next day your investment would forego the higher yield for the remaining 364 days over which it is locked up.
Investors are encouraged to match their minimum anticipated investment period with the interest rate risk of the fund selected. Although the money is always available, in this way the risk profiles are appropriately and conservatively correlated.
Fixed income investment is a comparatively low risk asset class, and within this class, funds range from low to medium risk.
The shorter interest rate risk funds are the money market funds which are capped at three-month interest rate risk and are currently returning over 0.5% above the repo rate. The next level up is cash plus and income funds. The range offers interest rate risk of up to one year. These funds include the Absa Core Income Fund (to be renamed the SIM* Core Income Fund). This popular fund aims to achieve returns that exceed money market funds by 0.5% to 1% annually. The running yield on the Absa Core Income Fund is currently higher than traditional money market funds while it has interest rate risk of around nine months. If rates have indeed peaked, this fund will proportionately lock in these higher yields due to its longer interest rate term exposure. However, if rates continue to move higher, around 85% of the fund is currently floating in nature and, like the overnight deposit, will re-rate higher over the following 90 days.
This type of fund is highly appealing as a cash alternative, since, based on past performance, it offers investors a higher yield with a floating rate structure, while interest rate risk is capped at one year for the Absa (SIM*) Core Income Fund.
The Absa (SIM*) Core Income Fund has managed to outperform a 12-month deposit over almost all recorded one-year rolling investment periods since it was created seven years ago. To view the performance history of this fund, you can view the Minimum Disclosure Document.
Traditional income funds are free to take additional interest rate risk, so they could increase returns in stable to falling interest rate environments. These funds’ interest rate risk is capped at two years and, for the patient investor holding for the appropriate investment window, could outperform. The SIM* Enhanced Yield Fund is a market-leading example of an income fund.
For investors with an investment horizon of at least one year, a flexible or multi-asset income fund matches this time horizon. These funds can take higher exposure to longer interest rate risk assets such as bonds while holding some floating rate instruments that will diversify the portfolio should rates continue to rise. These funds may also hold 45% offshore, including 10% equities. The Absa Tactical Income Fund (soon to be called the SIM* Tactical Income Fund) is a market-leading example of such a fund with a superior running yield. Its interest rate risk is just below two years. The fund still holds a current floating rate exposure of 70% of its assets, so proportionately, its yield will increase if policy rates do increase, but it will lock in yields for longer if they remain high or interest rate cuts start to be expected.
At Sanlam Investments, we offer a carefully managed selection of fixed income funds, ranging from cash plus, income funds, multi asset income funds up to our market-leading Absa bond fund (soon to be renamed the SIM* Bond Fund). These funds have diversified exposures and offer investors the comfort of liquidity. In this period of uncertainty and heightened volatility, we are seeing greater interest in fixed income investing with lower interest rate risk. While interest rates have moved higher and may remain at these levels for some time, it is a very compelling time to consider fixed income unit trust investing with Sanlam Investments.
*SIM is the abbreviation for Sanlam Investment Management.
Sanlam Investments consists of the following authorised Financial Services Providers: Sanlam Investment Management (Pty) Ltd (“SIM”), Sanlam Multi Manager International (Pty) Ltd (“SMMI”), Satrix Managers (RF) (Pty) Ltd, Graviton Wealth Management (Pty) Ltd (“GWM”), Graviton Financial Partners (Pty) Ltd (“GFP”), Satrix Investments (Pty) Ltd, Amplify Investment Partners (Pty) Ltd (“Amplify”), Sanlam Africa Real Estate Advisor Pty Ltd (“SAREA”), Simeka Wealth (Pty) Ltd, Absa Asset Management (Pty) Ltd (“ABAM”) and Absa Alternative Asset Management (Pty) Ltd (“AAM”); and has the following approved Management Companies under the Collective Investment Schemes Control Act: Sanlam Collective Investments (RF) (Pty) Ltd (“SCI”), Satrix Managers (RF) (Pty) Ltd (“Satrix”) and Absa Fund Managers (RF) (Pty) Ltd. Sanlam is a full member of ASISA. Please note that past performances are not necessarily an accurate determination of future performances, and that the value of investments/collective investment units/unit trusts may go down as well as up.
Although all reasonable steps have been taken to ensure the information in this document is accurate, Sanlam Investment Management (Pty) Ltd does not accept any responsibility for any claim, damages, loss or expense, however it arises, out of or in connection with the information in this document. No member of Sanlam gives any representation, warranty or undertaking, nor accepts any responsibility or liability as to the accuracy of any of this information. This document is intended for information purposes only and the information in it does not constitute financial advice as contemplated in terms of the FAIS Act. Use or rely on this information at your own risk. Independent professional financial advice should always be sought before making an investment decision. Past performance is not a guide to future performance. Changes in currency rates of exchange may cause the value of your investment to fluctuate. The value of investments and income may vary and are not guaranteed.
Collective investment schemes are generally medium to long-term investments. Please note that past performance is not necessarily a guide to future performance and that the value of investments /units/unit trusts may go down as well as up. A schedule of fees and charges and maximum commissions is available from the Manager, Sanlam Collective Investments (RF) Pty Ltd and Absa Fund Managers (RF) (Pty) Ltd . Additional information of the proposed investment, including brochures, application forms and annual or quarterly reports, can be obtained from the Manager, free of charge. Collective investments are traded at ruling prices and can engage in borrowing and scrip lending. The Manager does not provide any guarantee either with respect to the capital or the return of a portfolio. The fund may from time to time invest in foreign countries and therefore it may have risks regarding liquidity, the repatriation of funds, political and macroeconomic situations, foreign exchange, tax, settlement, and the availability of information. The Manager has the right to close any portfolios to new investors to manage them more efficiently in accordance with their mandates.