Page 175 - Profile's Unit Trusts and Collective Investments 2021 issue 2

Fund Manager Interviews

Please comment on your investment year (July 2020 – June 2021) from a fund manager's
point of view.
From an investment management perspective, it was a good year. We were able to buy some
bonds early in the financial year at still somewhat elevated spreads following the turmoil in the
first half of the 2021 calendar year, although the best opportunities came in the preceding quarter.
We had no credit events (and we wouldn't expect any anyway). In terms of performance though,
returns are very much driven by the rand exchange rate, and for the 12 months in question it
strengthened – from 17.4 per US dollar to 14.3 at the end of June 2021. It also strengthened against
the euro and sterling. This means that when the offshore bond returns are translated back into
rand the total return performance was negative for the year ending June. That is obviously
disappointing but beyond our control, and although we can hold up to 10% in the rand, we usually
keep it less than 1% as our clients are buying the fund for the offshore exposure and we don't want
active currency risk to crowd out the core return drivers of the portfolio.
In terms of risk management, what methods or strategies are you able to use to protect your
clients' investments?
First and foremost, this fund is designed to preserve capital, so we stay up in quality in order to
mitigate the risk of default. As previously mentioned, we will only buy investment grade bonds,
and we prefer bonds from issuers or capital structures where we have near term visibility over the
cashflows, with the highest probability of the bonds being paid back at maturity. We do not have
any control over the exchange rate, however, so investors need to accept the risk that comes with
offshore investing. That said, if inflation and interest rate differentials persist over time, then one
might expect to see the rand continue to structurally depreciate and investors' real wealth will be
enhanced by holding an offshore exposure.
Another way capital can be eroded is through excessive trading. We use liquidity funds to
manage residual cash to minimise the need to sell bonds which incurs additional transaction costs
as you cross the spread. We tend to hold most of our bonds to maturity, unless they are called or
tendered. When a bond is callable, we won't buy it unless we can buy it cheaper than the price at
which it would be called. This further reduces any drag on portfolio returns.
Please comment on the year ahead and, if possible, estimate the performance of your fund
over 2 or 3 years. What are your targets and objectives for the year ahead?
As portfolio return is driven largely by rand performance it is difficult to estimate nearer term
performance, but in local terms – before rand translation – we would expect a money market type
profile. Clearly today's yields are not very enticing, but it should preserve capital in what are not
cheap global markets. As the timeframe extends, we would expect some uplift in rand terms as the
rate and inflation differentials weaken the rand and offshore currency outperforms.
Offshore investments are heavily influenced by the rand. Please give your view on the rand
over the next 1, 3 and 5 years.
I draw on the research and wisdom of the broader team, and my colleagues on the ground in
South Africa, when it comes to shaping views on the rand. Suffice to say though that we see a
steady weakening of the currency in the years ahead as inflation differentials exert over time.
Please give your views regarding interest rate trends and the yield curve over the next 1 to 2
years. What interest rates can investors expect? Do you anticipate further repo rate cuts?
The interest rates curves that have the most direct impact on this portfolio, notwithstanding
FX moves driven by rate differentials which are also an important consideration, are those of the
US dollar, euro and sterling markets. We do not expect any meaningful move higher in policy rates
in the next 1 to 2 years as policymakers are likely to lift emergency measures before any rate hikes
materialise, so they remain some way off in our opinion, on the proviso inflation does indeed
remain "transitory," as is the favoured description today. Nonetheless, the path of rate expectations
is likely to be upward and we need to factor that into the portfolio's maturity profile in time. For
now, though, we are happy to invest a bit longer than the fund’s 3-month benchmark to capture
some of the additional term premium and spread offered today.

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Profile’s Unit Trusts & Collective Investments — Understanding Unit Trusts