Opportunities in global fixed income

South African investors have necessarily limited their exposure to global fixed interest bonds over the past several years for two primary reasons: unattractively low yields and the 25% offshore asset restriction for retirement portfolios under Regulation 28. Under the 25% limit, it made sense to allocate the global allowance primarily to global equities and cash, given the upside to potential returns of the former and high risk-reduction and liquidity benefits of the latter. However, the February 2022 increase in the offshore limit to 45% effectively opened up a new world of opportunities to South African investors, and at M&G Investments we believe global fixed-interest sovereign bonds, in particular, can offer considerable benefits to a local portfolio generally and currently present an excellent buying opportunity.

Why global fixed income?

South African investors have several good reasons to consider adding global bonds to their portfolios, the most important being their effectiveness in lowering the risk of local balanced portfolios.

Graph 1 shows how a standard balanced portfolio with 60% SA equity and 40% SA bonds experiences a significant reduction in risk (as measured by its standard deviation) as increasing amounts of global bonds are added: with no global bond exposure, the portfolio’s risk is around 12.5% p.a., which falls meaningfully to around 10% once an 18% weighting is reached, for example. This is due to both the diversification of geography, currencies and economies, and the inherent lower volatility of bonds as their weight expands in the total portfolio.

Taking a multi-faceted investment approach

We have identified eight elements that underpin our thinking about investing that apply across all types of assets, including global bonds.

1. Because the future is unknown, avoid strategies where success depends on forecasts such as interest rates, inflation and growth. Instead, rather employ a long-standing value-driven approach to identify assets that could perform strongly regardless of the economic cycle.
2. Eliminate as many unwanted and unrewarded risks as possible by ensuring all interest rate and currency risks in a portfolio are neutralised.
3. Take an active approach by taking advantage of credit market inefficiencies caused by investor overreaction, artificial barriers and silos that result in mispricing. Adding to this, selectively add or reduce portfolio risk as conditions change through individual stock selection.
4. Conduct extensive fundamental research in order to recognise pricing anomalies, remove barriers to investment and widen the opportunity set across different companies, currencies and geographies wherever possible.
5. Avoid low-probability strategies.
6. In our view, an investment should always have a value rationale, otherwise it is simply speculative.
7. Always ask whether investors are being compensated for the risk. There are no “bad” bonds, just incorrectly priced ones.
8. Have the patience to wait to invest at the “right” price, as this is the most underrated and best rewarded investment strategy that exists.

Creating outperformance

It is well known that it is difficult to achieve market-beating returns from global fixed income assets given the market’s huge size and high efficiency. However, the successful application of this philosophy and process over the past two decades, as well as choosing an excellent and experienced team of professionals, will deliver outperformance in fixed income portfolios.

Look for a global team of credit analysts covering more issuers and digging deeper to truly understand the companies’ strengths and weaknesses and how they impact credit risks. The analysts and portfolio managers can then be prepared for unexpected events that cause pricing anomalies and take advantage of them by already knowing which companies are more at risk, and which are more resilient to that type of event.

South African investors would be wise to consider the inclusion of an actively managed, carefully analysed and diversified mix of global fixed income assets to help improve the performance potential of their local portfolios on both a risk and return basis.