Commentary for the quarter ended 30 June 2023
Q2 2023 Performance review
The Northstar Income fund outperformed the STeFI x110% benchmark over the last 12 months, with a return of 8.26% vs. 7.21%.
The 37% weighting to fixed bonds contributed 3.41%, with solid performances from the R2030, R213, and ABS7 holdings. The 39% average weighting to Inflation Linked Bonds was the next best contributor of 2.19%, mainly due to holdings in I2025, FRBI25, SBSI14, and SBSI11. The balance of exposure in Gold (GLD 9%), floating rate notes 13%, and US Cash 2% contributed equally to the balance of returns.
Over the quarter, the fund has delivered softer returns of 84bps relative to the 2.1% from STeFI x110%. Fixed bond holdings of 31% detracted 8bps, and the 1% exposure to property detracted 3bps. The balance of exposures delivered positive returns, including our inflation-linked bonds, which contributed 30bps, despite the inflation-linked bond index providing a negative return of -74bps. The consolation is that the Northstar Income Fund outperformed the strategic benchmark by 46bps.
Market Outlook and Portfolio Positioning
Inflation continues to moderate, with one-year consensus projections at approximately 5% for SA CPI YoY and 2.75% for US Inflation. As a result, the market is anticipating interest rates to top out this year, with the only debate as to whether there will be another one or two 25bps hikes by the Fed.
The US yield curve remains steeply inverted, with the bond market anticipating much looser monetary policy from the Fed within the next two years. The factors driving this view are; 1) the Fed has inflation under control, and 2) the economy will experience a rapid slowdown. We believe the bond market is being over-optimistic (US10y trading as low as 3.38% during the quarter) and the yield curve remaining inverted for a year (US10y minus US2y at -1%), and yet no indication from the Fed that interest rates have peaked or when rates are likely to start moderating. Any upwards revisions to inflation or the economic outlook will likely see US bond yields rise.
Conversely, local fixed bonds have yet to price in lower interest rates and inflation and continue to reflect slowing economic growth and heightened fiscal risk. Despite softer commodity prices, the Rand and local bonds probably reflect unrealistically pessimistic outcomes, given the discipline of the SARB and their efforts to control inflation. The differential between the US10y and SA10y is near historic highs of 8%, despite the anticipated inflation differential at historic lows of 2%.
Local fixed-income assets look poised to deliver handsome real returns for investors; however, we remain vigilant with an underweight corporate bond holding, both locally and offshore. In addition, we hold inflation-linked bonds at the front end of the local curve and maintain an appropriate amount of exposure to Gold through the GLD ETF.
Overall, the Northstar Income Fund trades on a yield of 9.2%, with the prospect of further gains from our attractively priced fixed bonds on a 10.4% yield and 6-year maturity profile. From a risk perspective, the portfolio has a modified duration of 2.4 and a weighted average maturity profile of 2.8 years; however, and remains very well diversified across both local and offshore assets.
