By Ané Craig, Head of Fixed Income at PSG Asset Management

The first half of 2025 has been marked by persistent volatility and subdued returns across South African fixed income markets. Following a stellar performance in 2024, this year’s instability has left many investors questioning whether it’s time to retreat to the safety of cash. The instinct to seek refuge in liquid, lower-risk assets during uncertain times is understandable − especially when global markets appear jittery. But is a move to cash still wise when interest rates are headed lower?

The case for caution with cash

Over the past year, high real interest rates in South Africa made cash a competitive option. Investors were well-compensated for parking their cash in money market or call accounts. But this is changing. In May, the South African Reserve Bank (SARB) reduced the repo rate by 0.25%, after pausing their interest-rate cutting cycle that started in September 2024. The market anticipates at least one more cut before year-end.

As nominal interest rates fall, so too will the yields on cash investments. What looked like an attractive haven in 2023 and early 2024 may soon become a drag on returns. Simply put: as interest rates decline, the reward for holding cash diminishes.

Why income funds offer a compelling alternative

While cash remains useful for liquidity and short-term stability, income funds provide a more compelling solution for the current environment. These funds are designed to deliver returns that beat both inflation and cash, even as rates decline. They do this by taking on modest amounts of duration and credit risk, carefully managed to avoid the volatility of longer-term bonds, while still benefiting from falling interest rates.

When rates drop, the prices of income-generating securities, like bonds, tend to rise. Income funds are positioned to capture this upside, offering capital gains in addition to yield. This means that while cash returns decline in a period of rate cuts, income funds can potentially improve returns in this environment. As a result, in these periods the gap between returns from income funds and cash returns can widen significantly.

That said, South African bond yields remain elevated in part because of persistent fiscal risks: a high debt-to-GDP ratio, large borrowing requirements, and uncertainty around the pace of reform. These factors introduce volatility into the bond market, and this is why partnering with an expert to unlock the attractive available yields and manage portfolios dynamically as conditions change is recommended.

This embedded risk premium also means that any meaningful, sustainable improvement in economic growth or government reform could trigger a positive repricing of South African assets, including government bonds. The potential upside from such a shift could be significant and adds to the overall appeal of bonds, particularly for investors who have maintained exposure through flexible, actively managed income strategies.

A note on inflation targeting

An important development to watch is the potential adjustment to South Africa’s inflation targeting framework. Calls for a lower, more precise target, such as a move toward a 3% midpoint, signal a stronger commitment to long-term price stability. For fixed income investors, this would be a positive shift. Lower inflation expectations anchor lower long-term interest rates and can support stronger bond valuations over time.

Seek low-volatility, real returns in uncertain times

In an environment where uncertainty is high but cash rates are set to decline, investors should reconsider the role of cash in their portfolios. While cash holds a certain psychological appeal for investors during times of uncertainty, income funds offer the ability to exploit the yield curve to investors’ advantage, provided they partner with the right manager − one who can dynamically manage duration and credit exposure. Income-type strategies can play a valuable role in investor portfolios, offering both capital preservation and real return potential.

As we move through the remainder of 2025, staying agile and positioning portfolios to benefit from rate cuts while minimising risk will be key. Income funds, with their proven ability to outperform cash over time, are well-suited to play this role.