Beating cash at little extra risk

Coronation’s good calls on investments in inflation-linked bonds and offshore corporate bonds led to its relatively conservative income fund, which aims at returning a little better than cash, out-performing its peers in the broader interest-bearing category.

The Coronation Strategic Income Fund returned on average 9.8 percent a year over the three years to the end of December last year, according to ProfileData. This earned it the Raging Bull Award for top performance over three years among all South African bond, income and multi-asset income funds.

Investors can take comfort in the fact that the fund has sustained this performance over a decade. Its average annual return for the 10 years to the end of December was 9.84 percent.

The Strategic Income Fund is classified as a multi-asset income fund because it allocates between bonds, money market instruments, listed property and preference shares in line with the manager’s view on where the fund can earn the best returns.

It aims to out-perform the return you can earn from a cash investment, such as a money market fund, without taking too much extra risk.

Fund manager Mark le Roux says the aim of the fund is to out-perform the return from cash by two percentage points.

Over the three-year period to the end of December last year, you would have earned an annual average return of 5.82 percent from cash, so the Strategic Income Fund has well out-performed its target.

The fund has a flexible mandate, with no limits on the terms to maturity of the fixed-interest assets it owns or on the average duration of the terms to maturity of the instruments in which it invests.

Le Roux says the fund shifted aggressively into local inflation-linked bonds and offshore corporate bonds in 2009, after a big sell-off of these securities following the 2008 subprime crisis. This was the key factor that differentiated the fund’s performance from that of its peers, and these positions continued to pay off for the fund in 2011 and 2012, he says.

About 35 percent of the Strategic Income Fund’s returns over the past three years were a result of its positions in these two sectors of the fixed-income market, Le Roux says.

At one time, the fund had up to 20 percent in inflation-linked bonds, but recently it sold some of these bonds and took the profits. At the end of December last year, the fund had a more modest 7.6 percent in inflation-linked bonds.

When foreign investors sold off corporate bonds indiscriminately in 2009, the fund was able to buy them at double-digit yields, Le Roux says. It bought the corporate bonds of a number of blue-chip South African companies – including Old Mutual, Standard Bank and Naspers – at yields in some instances as high as 12 percent in hard currency terms.

When the demand for these bonds strengthened and the prices returned to more normal levels, the Strategic Income Fund benefited from the capital gains.

Last year was the worst year of the three-year period for the fund, because the All Bond Index returned only 0.6 percent, as opposed to 16 percent in 2012, and inflation-linked bonds returned only 0.8 percent, compared with 19.4 percent in 2012.

The dismal performance of these fixed-interest asset classes last year was driven by expectations that the United States Federal Reserve’s quantitative easing programme would taper off, Le Roux says. The United States Federal Reserve finally announced in December it would begin tapering.

With cash investments offering a better return than government and inflation-linked bonds, the Strategic Income Fund opted to keep a fair portion of the fund in cash last year. It ended the year with 36 percent in local cash and 1.5 percent in offshore cash.

The biggest portion of the fund remained in corporate bonds – 44 percent in locally listed bonds and 6.8 percent in offshore bonds as at December 31 last year.

Le Roux says listed property shares out-performed the bond market last year, but he has continued to add to the listed property portfolio, because these shares were sold off due to falling yields and the decline in the value of the rand against other major currencies.

At the end of last year, the fund had 5.2 percent in listed property and 1.5 percent in offshore property.

Preference shares make up another smaller allocation of the fund – 4.5 percent at the end of last year. Le Roux says Coronation favours these shares for their steady dividend yield and will continue to add them to the portfolio as opportunities arise.

The fund is limited in terms of its classification as a multi-asset income fund to investing no more than 25 percent in a combination of listed property, preference shares and international assets. Although these funds can invest as much as 25 percent offshore, the Strategic Income Fund has a self-imposed limit of 10 percent in foreign securities. This is to avoid the volatility that comes with the movements of the rand when larger amounts are invested offshore, Le Roux says.

Looking ahead, Le Roux says Coronation remains cautious despite the correction in the bond market last year.

With tapering in the US already under way, foreign investors may be more discerning when considering their investments in emerging markets, he says. The fund therefore remains invested in assets and instruments that Coronation believes are priced correctly for their risks, while limiting the potential to lose money and enhancing the income the fund earns.

The Strategic Income Fund is aimed at investors who will withdraw no more than three percent of the value of their investment each year. If you require a higher rate of income, Coronations says you should look for a fund with at least some exposure to higher-risk assets, such as equities.

The fund’s total expense ratio at the end of December was 0.97 percent a year.

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