In a world of zero-bound interest rates, South African bonds offer attractive returns compared to both developed markets and emerging market peers.
Interest rates globally have been steadily declining since the global financial crisis of 2008/2009. The United States (US) Federal Reserve, the European Central Bank and Bank of Japan all have interest rates close to zero.
An investor in a US treasury bond would earn a meager return of 1.5% after 30 years. Japanese government debt would give an investor an even less attractive return of slightly above 0.5% while an investor in German or Swiss sovereign debt would lose capital.
The aggressive 300 basis point rate cuts this year by the South African Reserve Bank (SARB) has reduced the repo rate to an all-time low of 3.5% in an effort to protect an already fragile economy from the negative effects of the Coronavirus (COVID-19) pandemic and resulting lockdown.
The historically low interest rate means South Africa is seeing similar effects to the global markets for the first time with falling yields as rates decline.
Money market funds are now offering returns of about 1% above the repo rate while a stable income fund offers around 2% above the repo rate over a 12 month period.
Investors wanting higher returns than those offered by cash deposits and money market investments have to consider other options.
They can move into asset classes that offer slightly more risk for a better return or move money offshore. Considering the low global interest rates, moving offshore is not necessarily the answer. For example, investing in an offshore income fund could earn you a zero percent return in the next 30 years.
There is, however, an opportunity to earn a better return in the South African bond market, especially for longer-dated bonds. South African bonds offer an attractive real return of just over 6%. In comparison, Brazil offers 4.5% and Indonesia 5.2%.
Investing in South African bonds over 10 years or longer gets you a 12% additional return in local currency compared to Switzerland where yield are negative out to 50 years.
Inflation linked bonds may be an attractive addition to portfolios with a return above inflation of between 4% to 5% over the entire period of the bond to maturity. South Africa’s inflation rate is currently slightly above 3% and expected to remain low for some time.
Although bonds are no longer considered safe haven assets, they are considerably less risky than equities. Investor should consider South African bonds, especially over a longer term, as they can play a valuable role adding real returns to a portfolio.