RSBs vs Bond and Income funds — a 10-year comparison

RSA Retail Savings Bonds are not only the safest interest-rate investment available to retail investors — they have also, consistently and comprehensively, outperformed every Bond and Income unit trust in South Africa over the 10 years to 31 October 2017.

A 5-year fixed RSB, simply managed using the Restart option whenever the prevailing rate moved above the held rate, returned 2.26% per year more than the average bond fund and 2.33% per year more than the average income fund over the decade. Compounded over ten years, that is better than 22.5% extra return, on the same capital, with lower credit risk.

We believe the differential is sustainable, because the structural advantages — the Restart option, no fees, the +0.50–1.00% spread RSBs are issued at over the same-tenor Government curve — are baked into the product design.

What we're comparing

For context, here is what the unit-trust universe looks like:

| | Income Funds<br>(Interest Bearing Short Term) | Bond Funds<br>(Interest Bearing Variable Term) | |---|---|---| | Aim | Returns above Money Market Funds, with capital stability | Beat the All Bond Index; returns above Money Market with capital risk accepted | | Suggested horizon | 1 year + | Typically 3 years + | | Duration | Less than 2 years (regulated) | Typically 4–7 years (not specifically regulated) | | Total AUM (Oct 2017) | > R110bn | > R20bn | | Credit exposures | Banks, Government, Corporate | Banks, Government, Corporate | | Number of funds | 35+ | 39+ |

Fund managers and marketers will counter the comparison with three arguments. We address each below.

Argument 1: "Funds offer Liquidity"

Investing in a unit trust gives you daily / overnight access. This is true most of the time — but the fund managers themselves usually suggest a 1-year horizon for income funds and 1–3 years for bond funds. Investors who genuinely need short-term access are usually steered toward money-market funds, not bond or income funds.

If a fund holds less-liquid parastatal or corporate paper, redemption can be restricted in stress. A recent example: investors in funds holding ABIL paper had part of their investment "side-pocketed" after the bank's collapse.

RSBs have their own liquidity rules — early redemption is at one interest payment of cost — so they're not the right product for cash you may need within a year. But once held for a year:

• Investors taking monthly interest forfeit roughly one month's interest as the redemption cost. Cheap.
• Investors on 6-monthly interest forfeit up to six months — much more punitive.

For an investor with a 1-year+ horizon, the RSB liquidity profile is comparable to a bond or income fund's suggested horizon, and the return differential (2%+) far outweighs the extra friction in a redemption.

Argument 2: "Funds offer Diversification"

Diversification is generally a good idea, but only when it produces better risk-adjusted returns. It is not a good idea when it just means adding additional credit risk to chase return.

• SA Government debt, including RSBs, remains the best credit available to a SA investor. See Is my money safe in RSA Retail Bonds?.
• Most bond and income funds have the mandate to invest in bank, parastatal and corporate paper. Many do, in pursuit of yield, which adds default risk. ABIL is the canonical example — funds invested in its bonds took capital losses when it collapsed.

Diversifying into lower-credit paper to chase 1% of extra yield, on a R100 000 investment, is R1 000 of extra interest a year — and very little if the issuer fails.

Argument 3: "Our Fund is better than average"

Some managers genuinely beat their peers. Picking the manager who will beat the peer group ahead of time is the hard part. Decades of academic research, and most retail investors' lived experience, says it's difficult. The best-performing fund also tends to change over time.

The point we make is stronger than "RSBs beat the average":

Looking at the spread of fund returns over the same 10-year period:

• *Even the best-performing bond fund underperformed the managed RSB by 1.30% p.a.*
• *Even the best-performing income fund underperformed by 1.93% p.a.*
• The worst bond fund underperformed by 4.36% p.a.
• The worst income fund underperformed by 2.86% p.a.

So you didn't just need to pick a fund — you needed to pick a fund that beat every other fund in its category, and you would still have done worse than a passively-managed Restart-using RSB.

Why does this happen?

The Restart option

The single biggest structural advantage. Bond funds carry interest-rate risk symmetrically — they win when rates fall and lose when rates rise. RSBs win when rates fall (the lock-in) and win when rates rise (via Restart). This asymmetry compounds.

Some commentators argue Treasury shouldn't offer this product because it's too generous to the saver. Our take: anything that improves South African savings outcomes is to be welcomed, and these bonds make up less than 0.5% of locally-issued government debt, so the cost to Treasury is small.

Fees

| | Bond Funds (Min–Max) | Income Funds (Min–Max) | |---|---|---| | Total Expense Ratio | 0.44% – 1.45% | 0.33% – 1.19% | | Initial Fees | 0.00% – 1.03% | 0.00% – 2.00% | | Broker Initial Fees | 0.00% – 3.42% | 0.00% – 1.14% |

Most funds have phased out initial and broker fees, but some still charge them. And it isn't always clear whether those fees are netted out in the published performance figures.

RSBs incur no fees. Zero.

Money flows

Funds are affected by other people's behaviour. When inflows are heavy the manager can't always deploy capital efficiently; when outflows hit during stress, the manager may have to sell into a falling market. Long-term holders effectively share the upside when rates fall, but get stuck holding the bag when rates rise.

With an RSB, you are fully invested at all times. The value of your investment is not affected by what anyone else is doing.

Positioning costs

Fund managers all claim to actively manage to their interest-rate views. Calling rates is hard, especially in South Africa where political risk and foreign flows dominate. Most managers stay close to their benchmark and try to add value through credit selection — which, again, means taking more risk to (sometimes) earn more return.

Even with the freedom to take credit risk and to position around interest-rate views, the average fund manager could not match the return offered by a passively-managed 5-year fixed RSB using only the Restart option.

Bottom line

For most retail investors with a 1-year+ horizon, the simple decision is:

Move your fixed-income unit-trust holdings into RSA Retail Savings Bonds.

You give up daily liquidity (which most investors didn't actually need). You gain about 2% per year, lower credit risk, and a structurally simpler product.