It has been good to be invested in money market funds over recent years. The Allan Gray Money Market Fund (the Fund) has returned 7.5% per annum over the last three years, compared to 5.1% from the JSE All Share Index and 5.5% inflation.
The South African Reserve Bank (SARB) lowered short-term interest rates by 25 basis points in March. Monetary Policy Committee members were divided on this decision, suggesting further rate cuts are unlikely. Keeping rates at current levels makes sense in the context of the SARB’s mandate to target inflation between 3% and 6%. February consumer price inflation was 4%, and is expected to increase due to higher VAT, energy prices and wages.
A counter argument is that overly tight monetary conditions are restricting the South African economy. The most noticeable indicator of this is that real GDP growth is barely positive – far below the level needed to address the country’s financial challenges. Similarly, the real lending rate is high, approximated by the 10% prime rate minus 4% inflation. It seldom makes sense to borrow money at a 6% real yield unless one expects similarly high real growth. South Africa does not have this luxury and, as a consequence, private borrowing in real terms is at the same level today as it was three years ago. Constrained borrowing means constrained investment, increasing the likelihood of continued low growth.
The market is currently pricing in a 65% chance of one further 25 basis point cut over the remainder of the year. If our view of tight monetary conditions is correct, it would not surprise us if the SARB cuts rates more aggressively than the market expects. This should be positive for the economy, but lower yields would imply lower future money market returns. With this in mind, we continue to manage the Fund with the maximum allowed maturity and coupon days. Reinvestments over the quarter were targeted towards one-year instruments at attractive real yields.