10 INVESTING AFTER THE DOWNGRADES 31 May 2017
INVESTING AFTER THE DOWNGRADES
GEORGE HERMAN Citadel Director and Chief Investment Officer
“
Politics and currencies ; these two factors have been the main drivers of volatility in the capital markets of late and the month of March was no different ,” says Catalyst Fund Managers in its latest monthly report .
Following the announcement by President Jacob Zuma of the reshuffling of cabinet ministers including the removal of the highly respected Minister of Finance , Pravin Gordhan and his Deputy , Mcebisi Jonas , the rand was the major release valve for the volatility . The rating agency Standard & Poor ’ s ( S & P ) subsequently downgraded the country ’ s foreign currency sovereign credit rating to subinvestment grade citing numerous
Looking on ‘ the bright side ’
Even after SA ’ s downgrades to junk status , Citadel Wealth Management prefers to ‘ look on the bright side ’. According to Director and Chief Investment Officer George Herman , it ’ s times like these that offer opportunities .
“ When other investors become forced sellers of South African bonds , we will have the opportunity to create attractive assets for our portfolios for many years to come . This is a good example of where active managers can effectively reduce risk prior to an event and , in so doing , protect capital and enhance returns . By comparison , the passive investor will now be forced to sell at a massive loss .”
Herman also refuses to use the term ‘ junk ’ when discussing the country ’ s downgrades .
“ While current local rhetoric is relying heavily on the term ‘ junk ’, you will notice that Citadel does not use this description at all . No investment is ‘ junk ’ simply because some foreign investor can no longer invest in it . As South African investors , our home market still provides opportunities , despite some critics now scoring us lower than before . For us at Citadel , the movie goes on and our task of managing our clients ’ wealth has not changed .”
Herman insists that in turbulent times such as these , it is essential to remain calm and objective , and not to become embroiled in emotional judgements . Ask yourself : were South African bonds ‘ junk ’ 10 days ago ? No . Has our probability of default increased meaningfully since then ? The answer , again , is no .”
‘ Junk ’ is not a word used by ratings agencies Standard & Poor ’ s and Fitch explains Herman .
“ The word ‘ junk ’ is merely a label developed among regulated investors who are not permitted to invest beyond ‘ investment grade ’ securities or countries . And yet the word carries tremendous weight and emotional currency , most of which is an inaccurate reflection of what investment grade or sub-investment grade actually means .”
According to Herman the term should be banished from the investment lexicon .
“ The attractiveness of an investment is determined by the objective of a client or investor and the mandate that client has
concerns , including the cabinet reshuffle . Fitch Ratings followed suit by downgrading both the local and foreign currency sovereign credit rating to BB + ( subinvestment grade ), citing similar concerns to those of S & P .
“ SA listed property stocks with offshore assets , such as intu , Capco and Polska Prop , that are considered rand hedge stocks , rallied following the downgrading by S & P while SA centric property stocks with higher SA property exposure , sold off ,” the report adds .
“ The SA listed property sector is arguably experiencing a growing offshore composition relative to local property exposure . Foreign exchange volatility is a feature we given the financial manager . That mandate may exclude many countries or asset classes and that exclusion doesn ’ t make those particular investments ‘ junk ’”. He likens global ratings agencies to film critics . “ They have a published and pre-determined set of credit scoring criteria and aim to identify risks with those scores when giving their ‘ outlook ’. You may decide that you ’ ll only watch movies rated above a certain level by a certain critic , because you agree with the criteria , and that ’ s a perfectly acceptable way of filtering the entire universe of movies to suit your particular taste .”
Herman says there are two messages to take from this analogy : 1 . If this critic rates a movie at a score lower than your cut-off point , it doesn ’ t make the movie ‘ junk ’. 2 . If the critic rates this movie lower than a score generally associated with a ‘ good ’ movie , it serves absolutely no purpose criticising the critic .
“ Global investment firms require an independent , objective party to rate or score the entire global fixed income investment universe . Their mandates are then set up to include only investments higher than a specific score and this universe of investments is then investable for them . Over the years regulations for global pension funds have been standardised and , in so doing , this has created what is now known as the investment grade universe ,” he says .
This is merely a line in the sand , since a distinction or limit needs to be set somewhere . “ On the continuum of risk , the difference between the lowest ranked security in investment grade and the highest ranked security in the non-investment grade list is absolutely marginal and most definitely not as binary as the inclusion or exclusion would suggest . The one investment can ’ t be described as perfectly acceptable while the next is labelled as ‘ junk ’. It is merely outside the predetermined universe of a certain set of investors .”
SA centric property stocks sell off after downgrades
need to contend with in the SA Listed Property sector . The upside of this feature is the increase in opportunities to build robust portfolios that can withstand local specific risks without having to utilise offshore allowances . That said , we believe in the long-term , outperformance will be driven by the selection of stocks exhibiting solid property fundamentals . Therefore the decision to select offshore stocks will be driven by a combination of solid property fundamentals , management teams and the need to diversify the portfolios .”
The report says that on local performance indicators , the SA Listed Property Index ( SAPY ) recorded a total return of 0.11 % for the month of March with the historic yield of the SAPY ending the month at 6.69 %, 10 bps higher than the 6.59 % recorded the previous month . The yield-to-maturity ( YTM ) on the Long Term Government Bond ( R186 ) weakened by 16 bps to end the month at 8.88 % ( 8.72 % - 28 February 2017 ).
From a global property perspective , the FTSE EPRA / NAREIT Developed Rental Index recorded a net total USD return of -1.80 % in March . The best performing listed real estate market was Hong Kong , which recorded a total USD return of 1.83 %. The US recorded the lowest total USD return for March of -2.96 %.