Know your ETF - 1nvest SA Bond ETF

Factors that spurred the inflationary pressures include global supply disruptions brought on by Covid, prolonged accommodative monetary policy and intensified fiscal stimulus during the pandemic. In addition, the war between Russia and Ukraine restricted energy and food supply, thus adding to fuel and food inflation. 

Most central bank policy makers were caught off-guard by the magnitude of the spike in inflation. The South African Reserve Bank is an exception as it began its hiking cycle in November 2021. The endeavour to increase interest rates in a bid to bring inflation to a halt comes at a cost of lower valuations for stocks while impeding economic activity. 

Low and stable inflation is beneficial for stock markets, governments, financial services providers and households. This is because most financial products are somewhat linked to inflation, thus providing certainty. Governments often borrow at the rate of inflation, which if elevated can open a door for ballooning debt.

Higher interest rates that accompany high inflation increase interest payments for indebted households and businesses, thus squeezing disposable incomes and net profits respectively. 

The performance of government bonds is influenced by a multitude of factors such as economic growth, political stability, revenue base, current account balanceand the rating of the country’s debt by S&P Global and Moody’s ratings agencies. The agencies research the sovereign’s ability to repay debt.

SA was welcomed to the Citibank world government bond index in October 2012. The index tracks investment-grade bonds from over 20 countries. The entry criteria are that total outstanding amount of a country’s issues must be above $50bn, domestic long-term credit rating must be at least A- or A3 by S&P or Moody’s and there must be no barriers to entry. Inclusion in the FTSE index enhances the ability to raise funds at a lower costs.

Unfortunately for SA, we were removed from the index in April 2020. This was bad news because there are funds that are mandated to invest only on investment- grade debt securities.

Investors therefore need to be compensated by earning a higher risk premium for holding risky bonds. Essentially, SA’s removal from the index has elevated borrowing costs for the government.

The current account balance, which has a considerable weighting on a country’s credit rating, came in at a deficit of R87bn in Q2 - the first shortfall since 2020 - from a surplus of R157bn in Q1. Financial outflows in the form of dividends paid to offshore investors contributed significantly to the Q2 deficit.

Like many other countries, SA is grappling with a growth problem. GDP slid an annualised rate of 0.7% in Q2 owing to historic blackouts and floods in KwaZulu- Natal, among other things. Manufacturing accounted for the biggest share (-0.7%) in the GDP decline. The finance, real estate and businesses sectors added +0.6% in Q2. These figures are likely to hamper SA return to the world government bond index. Ratings agencies usually review ratings at least twice a year.

S&P Global has the country’s rating on sub-investment grade (BB-), which is three notches below investment grade and just one notch above speculative investment grade. The agency downgraded SA credit rating to sub- investment grade in end-November 2017. However, the agency changed its outlook on the country’s rating to positive from stable in July, citing that the favourable terms of trade in 2021 have improved the external and fiscal trajectory. Power outages will continue to hamper SA’s trajectory towards sustainable growth and productivity. The debt burden from most SOEs will weigh on the fiscus, thus rendering it harder for SA to make its way bank to the world government bond index.

This ETF will suit investors who have a low risk appetite and want to diversify their portfolio. It has a total expense ratio of 0.29% and a suggested minimum investment period of about 3 years.