Fixed income enters a new phase

After significant rate changes, South African fixed income enters a constructive phase. Despite uncertainty around inflation, rates and geopolitics, the market offers opportunities for investors taking a view on duration, real yields and credit risk. The base case is for rates to pause, though one or two further repo rate increases remain possible. Inflation risks persist from El Niño and conflict, keeping oil prices elevated.

South African government bonds in the 12- to 20-year area remain attractive. Fiscal consolidation – a growing primary surplus, restraint on the public-sector wage bill, the commodity windfall and improved SARS efficiency – could help. If this continues, SA debt could approach investment-grade status, a tailwind for longer-dated bonds.

Balancing yield and duration

For advisers, a central question is how much duration risk a client should take for higher yields. Longer-dated bonds offer greater return potential because investors earn a term premium for taking on interest-rate risk. The trade-off is higher volatility, so balance depends on the client’s risk appetite, investment horizon and tolerance for capital fluctuations.

The positively sloped yield curve and attractive inflation-adjusted yields make longer-duration assets rewarding for investors who believe fiscal consolidation will continue, the lower inflation target will materialise, and economic reforms will support growth. Reform progress, including Operation Vulindlela, has bolstered local market resilience despite global headwinds.

But the risks can’t be underestimated. If fiscal consolidation is reversed or political stability under the Government of National Unity deteriorates, long-end yields could rise, eroding returns. Advisers need not make a binary decision on duration. Blending shorter- and longer-dated bonds can match portfolio duration to a client’s time horizon and risk profile while reducing dependence on a single market view.

Looking beyond headline yields

Yield alone doesn’t tell an investor whether a fixed-income opportunity is attractive. Real returns matter because the objective is to preserve and grow purchasing power. The SARB’s neutral real interest rate provides a useful reference point. Its steady-state neutral real repo rate is 2.5%, comprising a 0.5% real interest rate assumption for major global economies and a 2% South African risk premium.

This can be viewed as a minimum real-return expectation for a short-dated South African inflation-linked government bond. As maturity and duration increase, investors should expect an additional term premium to compensate for greater risk and volatility. For nominal bonds, advisers can compare the yield with that of an inflation-linked bond of similar maturity. The difference represents the market’s implied inflation expectation, or breakeven inflation rate. This provides a useful framework for assessing relative value. A nominal bond can add value if actual inflation comes in below the breakeven expectation, helping preserve or enhance purchasing power.

More than an income generator

Fixed income’s role in a portfolio extends beyond simply generating income. Shorter- and medium-dated bonds can help preserve capital while providing attractive yields without taking on excessive duration risk. The asset class can also provide diversification, both against equities and within fixed income itself.

The fixed-income universe encompasses local- and hard-currency sovereign debt, listed credit and private debt. These instruments have different risk-return characteristics and varying relationships with equity markets, inflation and interest rates. Corporate debt can provide additional yield, while inflation-linked bonds offer protection when inflation rises. Each has a different role to play, reinforcing the importance of constructing fixed-income portfolios rather than treating the asset class as a single homogeneous investment.

Government versus corporate debt

Government bonds currently appear particularly attractive, but corporate bonds and other income-generating instruments still have important roles. Government bonds generally offer greater liquidity and can be traded more readily as market conditions change, providing strategic and tactical flexibility. Their status as the highest-rated local-currency instruments can also strengthen portfolio credit quality.

Corporate bonds tend to carry greater credit risk and can be less liquid, although much current issuance is in lower-duration floating-rate notes. These can provide valuable yield enhancement over longer periods and contribute to returns across market cycles.

Credit spreads have compressed as demand has outpaced supply. Government bonds have also delivered strong returns following the formation of the GNU. Despite these gains, fixed income remains attractive if economic reforms, fiscal stability and a lower, achievable inflation target continue to support the asset class.

Don’t confuse yield with quality

The attraction of a higher yield should always be weighed against the risk being taken to earn it. Credit analysis requires a detailed assessment of an issuer’s financial strength, including leverage, debt-serviceability ratios, the quality and diversification of earnings, and the consistency of cashflow.

Non-financial factors matter too. Governance, management quality and track record, as well as environmental and social considerations, can all affect an issuer’s ability to meet its obligations. The structure of the investment is equally important. A senior, secured exposure with strong covenants carries a very different risk profile from a subordinated or junior instrument issued by the same company. An investor’s position within the capital structure will ultimately influence potential recovery should the issuer encounter financial difficulties. Liquidity should also be considered, particularly for private or unlisted debt.

A role in retirement portfolios

Fixed income can be particularly valuable for clients approaching or entering retirement, when sequence-of-returns risk becomes more significant. Poor returns early in retirement, combined with regular withdrawals, can permanently damage a portfolio. A core allocation to stable, income-producing fixed-income assets can reduce volatility and allow retirees to meet some income needs without selling growth assets after a market decline.

Government bonds also offer strong liquidity, helping clients transition from retirement savings into an income-generating portfolio. For some retirees, coupon-paying bonds can form part of a lower-risk income strategy, providing regular cashflows over the investment period.

Watching 2027’s risks and opportunities

Looking ahead, advisers should remain alert to domestic and global risks. The rapid growth of AI-related corporate debt is a concern, particularly if weakness in the AI investment cycle triggers a sharp US equity correction.

Geopolitical tensions are another risk. Escalating conflict that disrupts critical infrastructure or pushes oil above $120 a barrel could put renewed pressure on inflation and bond yields. High government debt in developed markets could also prompt investors to demand greater compensation for sovereign risk. But risks can create opportunities. Sovereign debt may outperform in countries making progress on inflation or benefiting from higher commodity and energy prices. After the rise in global bond yields during 2026, attractive entry points could emerge if severe risks fail to materialise. The challenge for advisers is to understand each client’s needs and balance duration, credit, liquidity and inflation risk accordingly.

This article was originally published in the November issue of MoneyMarketing SA and republished with permission.