Investing in South Africas inflation-linked bonds

The South African inflation-linked bond (ILB) landscape

The inflation-linked bond market has grown considerably since the government issued its first inflation-linked bond, the 13-year R189 bond, in March 2000. The government remains the largest issuer, but the market has expanded to include state-owned companies (SOCs), banks, and corporate inflation-linked bond issuers. The market’s size and liquidity have increased to the point where investors can get reasonably diverse exposure to this inflation-hedging asset across a range of issuers and durations. By the end of 2023, the market value of the JSE IGOV Index was R468 billion compared to the R2 744 billion market value of the JSE GOVI Index.

What makes ILBs appealing to investors in the current inflation context?

The inflation outlook is complex and uncertain. After rising to a multi-decade high of 7.8% in July 2022 and declining to 5.3% in May 2024, inflation is still subject to numerous risks. These include geopolitical risks that could increase energy and food prices if they materialise and the impact of extreme weather and climate crises on the price of food. Globally, services inflation remains high, and central banks acknowledge the various longer-term inflation risks.

With the domestic consumer price inflation rate running above the Reserve Bank’s 4.5% year-on-year target, the midpoint of its 3% to 6% target range — and developed market inflation rates still above their target ranges — inflation remains a risk that needs to be mitigated if investors want to ensure that their capital and income will maintain their purchasing power over time. ILBs provide that security.

What do ILBs offer South African investors?

As the only financial asset that provides investors with explicit inflation protection,

Inflation-linked bonds offer South African investors the opportunity to hedge their capital against inflation. Improved diversification in the ILB market also allows investors to spread their exposure across instruments, sectors and issuers.

Relatively low-risk investment

Inflation-linked bonds, particularly if issued by the government, are relatively low-risk investments. Unless the government or issuing company defaults, investors will receive semi-annual inflation-linked coupons as well an inflation-linked capital repayment over the investment period. These instruments ensure inflation beating returns provided that investors remain invested until the bond matures.

Diversification

ILBs have distinct diversification benefits in a portfolio because they can hedge against inflation. Other assets like equities and nominal bonds do not have built-in protection against inflation. Thus, when inflation rises materially, inflation-linked bonds often outperform their nominal bond counterparts.

Why should investors consider core ILB funds?

1. Active management in a complex environment

   By investing in inflation-linked bond funds like the Futuregrowth Yield Enhanced Long Duration ILB, investors can access the skills of investment professionals who actively manage the fund’s investment positioning through complex inflation, macroeconomic and geopolitical conditions. 

2. Risks mitigated with risk management mandates

   As with all of our mandates, Inflation-linked bond funds are carefully managed from a risk perspective. For instance, Futuregrowth’s Core ILB Fund invests primarily in AAA+-rated instruments and has more than 90% of the portfolio invested in government-backed inflation-linked bond issues, which means that the government guarantees the repayment terms of the bond.

3. Diversification across duration and instruments

   Futuregrowth’s ILB funds invest across the market spectrum, ensuring that the funds offer diversified exposure across instruments, credit ratings, issuers and sectors.

4. Real return preservation

   The primary objective of Futuregrowth’s inflation-linked bond suite  is to consistently generate market and benchmark beating real returns over a rolling 3-year period.

What are the main benefits of investing in South African ILB funds?

Core ILB funds invest across the entire spectrum of the inflation-linked bond market in issues with different maturity dates and coupons and issued by different entities, including the government, SOCs, and corporations. Thus these funds give investors exposure to the full scope of the inflation-linked bond market, and provide protection from inflation across a diverse portfolio of assets. These funds are relatively low-risk from a counterparty risk perspective because the lion’s share of the assets is typically invested in government-issued inflation-linked bonds.

The unique positioning of the Futuregrowth ILB funds?

The Futuregrowth suite of Inflation-linked bond funds is unique in that these funds offer investors access to fixed-interest investment skills that have developed over three decades. As an asset management company, Futuregrowth has also focused on empowerment and creating developmental products since its inception. Thus, it invests for the future while generating benchmark-beating returns.

Our ILB funds are invested in listed and unlisted inflation-linked bonds and thus have access to a wide spectrum of opportunities available in the South African market. Based on its long-standing relationships, Futuregrowth’s investment team has access to a continuous deal pipeline, putting it in a strong position to source the attractive yield-enhancing opportunities in an ever-evolving credit market. It has specialist structuring skills in the unlisted space to protect investors and achieve risk-adjusted returns in line with the funds’ target to outperform the relevant JSE ILB Indices.

Another unique feature of Futuregrowth’s ILB funds is that they expose investors to a variety of infrastructure and developmental assets, with an instrument mix not typically available in most inflation-linked bond funds. These assets comprise almost 5% of the Core ILB Fund’s market value exposure (and 7% for the Yield Enhanced funds) – spanning across renewable energy, transport and broader infrastructure, including developmental sectors like affordable housing and agriculture. The rest of the market value exposure across the funds is invested in government inflation-linked bonds, banks, corporate credit and SOCs.  

The bottom line: inflation protection

Inflation rates may be declining, but the outlook remains uncertain, with a host of risks that could pose headwinds in the fight against inflation. ILB funds provide investors with inflation protection across a diverse universe of issuers, sectors, and maturities. Thus, they are well worth considering as one component of an investment strategy that will be able to navigate all the uncertainties that lie ahead.