Ninety One High Income Fund update

Our bottom-up views remain consistent with a preference for assets with defensive credit qualities; our preferred sectors remain banks and insurance, while looking for companies displaying strong asset quality, valuation, contractual cash flow and conservative management.

Apr 28, 2020

5 minutes

Our bottom-up views remain consistent with a preference for assets with defensive credit qualities; our preferred sectors remain banks and insurance, while looking for companies displaying strong asset quality, valuation, contractual cash flow and conservative management.

Performance review

For the quarter, the portfolio marginally underperformed the benchmark.

The portfolio’s enhanced yield over the 3-month JIBAR (Johannesburg Interbank Agreed Rate) continues to generate outperformance. Spread widening, predominantly across senior and subordinated bank debt, detracted from returns.

Market background

The first quarter of 2020 has been characterised by the humanitarian and economic crisis currently playing out as a result of the coronavirus (COVID) pandemic. Global markets were fast to react to rapidly changing economic conditions, while globally, governments and central banks have been quick to put in measures to address the economic impacts of extended periods of lockdowns. The US Federal Reserve (Fed) was quickest out the gates among the leading central banks, and by quarter-end had slashed rates by a cumulative 150 basis points (bps), committed to unlimited quantitative easing (QE) and an unprecedented venture into corporate bond purchases following congressional approval. On the fiscal side, the White House agreed a US$2 trillion stimulus package in order to shore up the defence against COVID-19. While China was initially the hardest hit economy from the deadly spread of COVID-19, the country now seems to be slowly returning to normalcy, following strict and intensive lockdown measures implemented by authorities. To add to the volatility, the oil price war amongst OPEC members amid an unprecedented demand shock depressed Brent oil prices to US$22 dollars a barrel.

In South Africa, the weakness in the local economy will no doubt be further intensified by the strict lockdown measures implemented by government on 27 March 2020, which has sent the entire economy into hibernation, barring essential services. The South African Reserve Bank (SARB) cut the benchmark interest rate by 1% to 5.25% at its 19 March Monetary Policy Committee (MPC) meeting. Following extensive engagement with market participants, the SARB increased and extended the tenor of their repo operations and took the historic step to support South African government bonds in the secondary market. The SARB, however, emphasised that this is a monetary policy reaction designed to facilitate the transmission of monetary policy – not QE or monetization of the deficit. In what felt more like a sideshow amid the coronavirus outbreak, ratings agency Moody’s unsurprisingly downgraded South Africa’s sovereign credit rating to one notch below investment grade at Ba1. The negative outlook was kept in place, foreshadowing the risk of a further downgrade within the next 18 months. The move meant that South Africa will no longer form part of the FTSE World Investment Grade Bond Index (WGBI) effective 1 May 2020.

The local credit market began to significantly reprice towards the end of the quarter, driven largely by the more liquid financial sector. Bank senior spreads widened on average 10 – 50bps across the curve. 5-year wholesale bank deposits (NCDs) currently middle at 1.5% above cash rates. Subordinated debt and alternative tier-1 (AT1) paper showed the most significant moves on average, repricing 150-200bps and 200-270bps respectively. In addition to the measures put in place by the SARB to facilitate liquidity in the bond market, the prudential authority announced various measures of relief to the banking sector in terms of capital and liquidity requirements and relief in terms of Risk Weighted Asset requirements on “COVID-19 related restructures”.

The corporate sector has been slower to react as the first rush for liquidity in the market flowed through the financial sector, however as the economic impacts of the local lockdown begin to be realised, we expect corporate spreads to reflect this in their pricing. State-owned enterprise (SOE) spreads have remained relatively stable, having not participated in as much of the spread compression over the past 2 to 3 years. After a reasonable month of issuance in February, where the banks, Vukile, Transnet and DBSA all placed paper in the market, March showed a marked decline with just under R4 billion of auctions being cancelled. Investec Bank, Growthpoint Properties, Mercedes-Benz SA and Netcare managed to privately place R5.5bn of bonds in the market over the month. Looking forward, we expect refinance requirements to drive the majority of issuance, with a likely increase in funding requirements of the banks driving financial issuance higher as a result of an increase in non-performing loans.

The saga at Eskom is ongoing, with its funding plans back in the headlines as COSATU presented proposals to the government to use the PIC to fund the utility earlier in the quarter. No further developments have been seen in this regard, while in interim the courts ruled against Eskom’s urgent application to have NERSA’s ruling on tariff hikes increased. The utility implemented intense load shedding in early March but has cited a decrease in demand for electricity as a result of the local lockdown taking further load shedding off the table for now until normal demand levels return. The spread on Eskom’s government-guaranteed bonds continue to tighten marginally as investors favour the additional yield for government credit risk.

Looking forward, as the local lockdown gets extended and we start to see the financial impacts filter through into the economy, we expect all sectors to experience an unprecedented fundamental deterioration. Balance sheet strength and strong management will be the credit differentiator amid the volatility and uncertainty. In the current environment, market volatility will present opportunities to lock in attractive credit spreads well in excess of the increased fundamental risks associated with the coronavirus pandemic and the resultant lockdown.

Portfolio activity

A preference for liquidity characterised the market towards the end of the quarter, creating volatility in bank senior and subordinated spreads. We continue to look for liquidity in short-dated assets which have rolled down the curve and thus trade at tighter credit spreads. In doing so, we marginally trimmed shorter-dated bank senior, subordinated and corporate debt over the quarter, while also reducing exposure to Nedbank Tier-1 paper before spreads moved wider.

Outlook and strategy

Our bottom-up views remain consistent with a preference for assets with defensive credit qualities; our preferred sectors remain banks and insurance, while looking for companies displaying strong asset quality, valuation, contractual cash flow and conservative management. We have become more constructive on the SOE sector as valuations are compelling, looking for opportunities to lend into entities with improving governance and sound fundamentals.

We see value in SOE spreads at current levels and currently have increased investments in Transnet senior unsecured bonds offering attractive yields on an outright basis and substantial enhancements to bank debt. We assess the sector on a case-by-case basis, strictly monitoring ESG risks amid the reforming political environment.

We are holding back liquidity, waiting for opportunities to deploy into higher-yielding paper to our preferred sectors and counterparties. We expect to be able to add significant yield to the portfolio in the current environment, while remaining conservative in sector and name selection.

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Important information

All information and opinions provided are of a general nature and are not intended to address the circumstances of any particular individual or entity. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. No one should act upon such information or opinion without appropriate professional advice after a thorough examination of a particular situation. This is not a recommendation to buy, sell or hold any particular security. Collective investment scheme funds are generally medium to long term investments and the manager, Investec Fund Managers SA (RF) (Pty) Ltd, gives no guarantee with respect to the capital or the return of the fund. Past performance is not necessarily a guide to future performance. The value of participatory interests (units) may go down as well as up. Funds are traded at ruling prices and can engage in borrowing and scrip lending. The fund may borrow up to 10% of its market value to bridge insufficient liquidity. A schedule of charges, fees and advisor fees is available on request from the manager which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. Performance shown is that of the fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax. There are different fee classes of units on the fund and the information presented is for the most expensive class. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. Where the fund invests in the units of foreign collective investment schemes, these may levy additional charges which are included in the relevant TER. Additional information on the funds may be obtained, free of charge, at Ninety One SA (Pty) Ltd (“Ninety One SA”) is an authorised financial services provider and a member of the Association for Savings and Investment SA (ASISA). Investment Team: There is no assurance that the persons referenced herein will continue to be involved with investing for this Fund, or that other persons not identified herein will become involved with investing assets for the Manager or assets of the Fund at any time without notice. Investment Process: Any description or information regarding investment process or strategies is provided for illustrative purposes only, may not be fully indicative of any present or future investments and may be changed at the discretion of the manager without notice. References to specific investments, strategies or investment vehicles are for illustrative purposes only and should not be relied upon as a recommendation to purchase or sell such investments or to engage in any particular strategy. Portfolio data is expected to change and there is no assurance that the actual portfolio will remain as described herein. There is no assurance that the investments presented will be available in the future at the levels presented, with the same characteristics or be available at all. Past performance is no guarantee of future results and has no bearing upon the ability of Manager to construct the illustrative portfolio and implement its investment strategy or investment objective. A feeder fund is a fund that, apart from assets in liquid form, consists solely of units in a single fund of a CIS which levies its own charges which could then result in a higher fee structure for the feeder fund. In the event that specific funds are mentioned please refer to the relevant minimum disclosure document in order to obtain all the necessary information in regard to that fund. This presentation is the copyright of Ninety One SA and its contents may not be re-used without Ninety One SA’s prior permission.