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SIMON BROWN: I’m chatting to Sylvester Kobo, Deputy Head Fixed Income at STANLIB. Sylvester, appreciate the time today. It’s been a wild start to the year. Locally our budget got delayed a couple of times, we’ve got tariffs, we’ve got a global tensions all over the world happening.
I want to start with you with perhaps what is perhaps the hard question – what would you consider a fair value for our currency and our bonds at the moment? Certainly we saw the rand out at almost R20/dollar earlier in the year, back around R18/dollar. Is there a fair value? Where would you peg it?
SYLVESTER KOBO: I think, Simon, it has been a wild ride indeed. In terms of fair value, we actually now hold a negative view on both the rand and South African bonds. We expect them to weaken over the next few months, largely driven by the worsening fundamentals both locally and offshore. We are of the view that the strength we’ve seen currently is driven by the weaker dollar environment and lower oil prices which have spurred on the sentiments across emerging markets, and South African bonds and the rand have benefitted.
Looking ahead specifically for the rand, we think that the worsening geopolitical picture with escalating conflicts across the world will work against it. But also we think as the market starts cutting down on expectations of interest-rate cuts by the US Federal Reserve, coupled with the passing of what’s called the ‘big beautiful bill’ in the US Congress, this will lead to a stronger dollar environment as the year unfolds, pushing the rand to around R18.50/dollar by year end.
SIMON BROWN: Okay, so weaker but not massively weaker. Looking at that, how do you and your team consider tactical asset allocation, because you’ve obviously got a flexible mandate, and that must certainly help? How do you kind of then piece together your allocation in that regard?
SYLVESTER KOBO: So when we consider tactical asset allocation we look at fair values – first with nominal bonds, or South African bonds as commonly known. We think going into the Medium-Term Budget Policy Statement, now Treasury will be updating their fiscal matrix, which will be worse than what they budgeted in the third iteration of the budget; they expect around 1.4% growth. We think it comes below 1%, which will lead to wider budget deficits, pushing bond yields higher.
So for the 10-year bond, we think fair value is around 10.5%. And, seeing as it’s currently around 10%, the total returns just will be around 8%. Compared to money markets that’s giving you 8.7% credit as proxied by income funds. We think it will return around 9.5% and inflation-linked bonds around 10%.
So, as you can expect, we’ve been shifting away from nominal bonds, cutting the exposure from around 60% in the Flexible Income Fund to about 20% now. And then we’ve bought more liquid highly-rated credits and increased that exposure to about 30% of the portfolio and bought some dollars because we expect the rand to weaken from now on.
SIMON BROWN: I get the point. I mentioned the flexible mandate and it is, I imagine, quite an asset – pun intended – I suppose, for you and your team to have that slightly more flexible mandate.
SYLVESTER KOBO: Exactly. It allows us, when things go pear-shaped – like they did around April with the Liberation Day and so forth – to actually cut the risk materially to protect clients’ capital. And then when things start coming down and we hold a more positive view, we can dial up the risk and go into riskier assets to get better capital returns. So it gives that flexibility. And for managers that really utilise it, they can give clients good return outcomes over many years.
SIMON BROWN: And you are utilising it to that degree. As you say, Liberation Day – markets were under pressure already when that happened. The US 10-year went over 4.5% at that point in time. You are responding practically in real time.
SYLVESTER KOBO: You have to. Since Covid this market has been close to impossible. So you really need to be nimble, dynamic in your approach. And whenever new credible material information comes through you need to shift around the allocations.
You mentioned our Flexible Income Fund. You can see consistent outperformance, one-year return or alpha of about 5%, and then three-year 3% over the three and five years. That’s as a result of that dynamic approach to asset allocation.
SIMON BROWN: Yes, and that absolute flexibility. A quick last question. A lot of folks when they look at this think, ah, but it’s bonds, it’s government bonds; I’m worried about the government. We certainly have seen some EMD [emerging markets debt] defaults in the past. The likelihood of a default by the South African government on their debt? It’s tough out there. The budget was tough, as you say. It’s probably going to get tougher in October and in budgets going forward. My sense is the likelihood of a default by our government I want to say is zero. Maybe never say zero, but it is immensely low.
SYLVESTER KOBO: It is very close to zero. Countries that have defaulted or even re-profiled their debt are largely borrowing US dollars because, as you can imagine, when local fundamentals worsen their currencies become weaker. It becomes impossible to get the dollars to pay down their debt, so then they default, whereas in South Africa’s case over 90% of our debt is in rands. So at the worst, if we really can’t afford to pay back, we can print the rands – which will be hyperinflationary, but we won’t default. We’ll always just print money if it gets to that to pay down our debt.
SIMON BROWN: Absolutely. It’s an inflation risk, perhaps, more than anything else.
We’ll leave it there. Sylvester Kobo, Deputy Head Fixed Income at STANLIB, I appreciate the time.
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