3. Fixed Income - Introduction
• An issuing authority (Government – Agency – Corporate – Municipality) issues a Bond
(aka Gilt) where they promise to pay a certain % interest rate (mostly fixed) every six
months for a certain number of years (duration) and the capital at the end of the period.
There are also Inflation Linked Bonds and the so called zero coupon bonds.
• The valuation is based on the ruling interest rates in the market, the duration of the
bond and the credit rating of the issuer
• Simplistically if 30 year interest rates are 10% and the issuer is issuing a 8% bond of
R1m over 30 years, the issuer will be able to “sell” the bond at R1m / 10 * 8 = R0.800m
• The purchased will “make” money if rates fall and “loose” money if rates rise. I.e. if you
bought at an 8% yield and rates go to 9%, your investment is worth less.
• The capital value at the end of a 30 year bond has very little value in the calculation
• This is the same for ALL duration bonds (only overdraft has no duration)
• You (normally) pay TAX on interest received
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9. EM local currency debt vulnerable to global risk appetite
Cumulative Foreign Bond flows per calendar year
80
2000
60 2001
2002
40
2003
2004
20
R Bn
2005
2006
0
2007
2008
-20
2009
2010
-40
2011
-60
Dec Jan Feb Mar Apr May June July Aug Sep Oct Nov Dec
Source: INET
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9
13. Source: StatsSA
-30
-15
-10
-25
-20
5
0
-5
20
25
10
15
Telecommunication (equip)
Hotels
Recreational equipment
Furnishings
Appliances
Vehicles
upside price risks
Postal & telecom services
Footwear
the 3% lower target band
27% of the basket is below
Personal care
Clothing
Medical products
Maintenance & repairs
Financial services
Other (funeral costs)
Owner's equivalent rent
Percentage change in CPI categories for 2011
Recreational services
Insurance
Tobacco
34% of the basket is
within the target band
Non-alcoholic beverages
Actual rentals for housing
Domestic worker wages
Alcoholic beverages
Food, fuel and administered prices remain
Restaurants
% y/y change in CPI categories for June 2011
Medical services
Public transport
Food
Tertiary education
Primary and secondary education
Water & services
the 6% upper target band
Stationery, books
39% of the basket exceeds
Private transport
Electricity and fuels
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14. Traditional valuation metrics not very effective at present
-’ve Output +’ve Output
Global gap / gap / Current
Deflation Reflation
G4 Inflation
Protected 0.50% 2.00% 0.00%
Securities
SA risk premium 2.00% 1.00% 2.43%
Inflation exp (1 yr
4.00% 6.00% 5.50%
fwd)
Supply premium /
0.50% 0.00% 0.50%
discount
Fair Value 7.00% 9.00% 8.43%
Source: Bloomberg, Momentum Asset Management
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15. Cash – An investment opportunity?
• Cash (for an individual or a tax paying entity) is actually only a good investment when
everything else is falling
• Scenario
• Real yields (i.e. above inflation) will most likely average abut 3% over time
• Inflation (optimistically) will probably average 5% over time
• Therefore cash should give you 8% BEFORE TAX
• Therefore if you are an individual at marginal tax rate – you will earn (after tax) LESS
than the inflation rate.
• You will at best stand still over time
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18. The US of AA+
US government debt as % of GDP
US government debt is near 100% of GDP.
Not AAA credit rating stuff.
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19. Barack Obama – 08 August 2011
“Markets will rise and fall, but this is the United States of America.
No matter what some agency say, we’ve always been and always will be
a AAA country.”
Source: Bloomberg
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