Catch this insight by Intellidex on the Satrix Inflation-Linked Bond (ILBI) ETF. Inflation-linked bonds are valuable for investors seeking an annuity stream. The Satrix ILBI ETF can be used as a building block for a core portfolio or for a core-satellite strategy, depending on inflation levels and the investment period.
Intellidex insight: Inflation-linked bonds (ILBs) are securities designed to help protect the purchasing power of investors’ investments. The bonds are indexed to inflation so the principal and interest income increases/decreases in line with inflation. However, this does not mean that returns for investors who do not hold the bonds to maturity are a linear function of inflation. While interest received from bonds increases in line with inflation, the capital gains portion is driven by market forces such as investors’ expectations of future inflation, expectation of interest rates and credit ratings, among others. Thus, prices for ILBs fluctuate, reflecting investors’ perceptions of various economic drivers.
One aspect weighing on ILBs held by local ETFs is SA’s deteriorating credit ratings. SA’s long-term local and foreign debt is rated as junk – below investment grade – by Fitch and S&P and its last investment grade rating – by Moody’s – hangs by a thread. That said, the negative investor sentiment on SA bonds coupled with fears of a global recession have driven yields (prices) of emerging market bonds up (down). SA’s benchmark 10-year bonds are offering a real yield (yield above inflation) of 4.21%, which is one of the highest on the market.
The Satrix Inflation-Linked Bond ETF is one the three ETFs that track ILBs issued by the South African government. Other than fees where Satrix’s ETF is the most competitive with a total expense ratio of 0.25%, there is little separating the three funds. They exhibit similar risk and return characteristics. The Ashburton Inflation ETF is the largest with assets under management (AuM) of R327m. Satrix and NewFunds have AuMs of less than R100m each. This implies the Ashburton Inflation ETF is a bit
safer from a liquidation point of view.
Fund description:The Satrix ILBI tracks the value of the S&P South Africa Sovereign Inflation-Linked Bond index. It is a comprehensive, market value-weighted index tracking the performance of South African rand-denominated inflation-linked securities issued by the South African government.
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Satrix Inflation-Linked Bond (ILBI) ETF
Top holdings: The Satrix ILBI holds 10 bonds with maturities of between three and 31 years. R197, I2025 and R210, R212 and I2029 which mature within the next three to 10 years account for slightly more than half the fund. The balance is in bonds with maturities of 14 to 31 years.
Suitability:Inflation-linked bonds are valuable for investors seeking an annuity stream. They can be used as a building block for a core portfolio or for a core-satellite strategy, depending on inflation levels and the investment period. Bond portfolios are more responsive to interest rate changes over longer investment periods.
Historical performance: Still a young fund, the Satrix ILB ETF slightly lags consumer inflation over one year.
Fundamentals: Bonds are driven by investor expectations on factors including the issuer’s credit profile, liquidity, interest and inflation. With South Africa’s bonds rated below investment grade by two of the three major rating agencies, perceptions of SA’s ability to repay its loans when they are due will remain key to the performance of bond ETFs. Any government actions or events perceived to compromise SA’s fiscal standing, such as slow economic growth and fiscal indiscipline, will likely cause yields to rise, which will dent bond prices. SA’s lack of economic growth and the problems at state-owned enterprises weigh heavily on the government budget. As such SA bonds currently offer high yields.
Inflation-linked bonds are sensitive to inflationary expectations, among other factors. The nominal value of the bond is adjusted to account for changes in inflation which effectively keeps the real value of the notional investment constant. So generally, when inflation increases and all other factors remain constant, there will be downward pressure on yields and vice versa.
Alternatives: A direct alternative of the Satrix ILBI is the NewFunds ILBI ETF, which has a TER of 0.35%..
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Satrix Inflation-Linked Bond (ILBI) Fact Sheet
Background: Exchange-traded funds (ETFs)
Exchange-traded funds (ETFs) are passively managed investment funds that track the performance of a basket of pre-determined assets. They are traded the same way as shares and the main difference is that whereas one share gives exposure to one company, an ETF gives exposure to numerous companies in a single transaction. ETFs can be traded through your broker in the same way as shares, say, on the Easy Equities platform. In addition, they qualify for the tax-free savings account, where both capital and income gains accumulate tax free.
Benefits of ETFs
- Gain instant exposure to various underlying shares or bonds in one transaction
- They diversify risk because a single ETF holds various shares
- They are cost-effective
- They are liquid – it is usually easy to find a buyer or seller and they trade just like shares
- High transparency through daily published index constituents