Ray Wallace, the CIO at Taquanta Asset Managers, who have managed Nedgroup Investments’ cash products since inception, provides an overview of what’s been happening in the Cash Solutions funds over the last six months – Prime Money Market Fund, Money Market Fund, Corporate Money Market Fund and the Core Income Fund.
Performance vs benchmark
The benchmark for the money market funds is STeFI call. On a 1-year rolling basis, STeFI call was at 6% at the end of June 2020, whilst the actual daily rates on call balances are now down to 3.5%, a result of the sudden substantial decline in interest rates over the last few months. All of the funds have outperformed the benchmark quite substantially, with the Money Market and Corporate Money Market funds performing approximately 150 bps above call rates. The Prime Money Market Fund is still growing and was able to maintain a competitive yield, despite only having international single A- and above rated instruments in the portfolio.
Core Income Fund: The Fund has offered substantial real returns against the STeFI composite benchmark, especially over the Covid crisis period, despite a conservative stance and very high levels of liquidity. The yield also stood up very well against our competitors in the income fund space, with lower volatility. We avoided the Land Bank issue too, as we had got our money back from them in January, after they breached a management-change clause. Corporate Money Market Fund: We’re currently at a gross running yield 5.22%, in line with the rate decline we predicted after the last 50bps rate cut in May. This rate should;d decline further over the next few weeks to around 5.08%. Core Income Fund: We’re currently at a gross running yield of 5.65% and predict a further decline as a result of the May rate cut to a predicted yield of around 5.60% over the next few weeks, with more than a 200 bps gap between the Fund yield and the current call yield (and inflation), which is a substantial amount of alpha if you want to maintain real asset growth.
Portfolio positioning: money market funds
The Corporate Money Market Fund is more conservative than the traditional Money Market Fund in that it only has big banks, international banks and government paper while the traditional Money Market Fund has some additional minor exposure to corporates. The Prime Money Market Fund is geared towards investors who are concerned about exposure to SA assets with its main exposure to HSBC Bank, Bank of China and China Construction Bank (i.e. only assets rated A- and above on an international rating scale).
Credit exposure in the Core Income Fund
This Fund has a similar, conservative approach with most of its exposure to the big five banks and very small exposure to SA corporate currently. We want to wait and see what happens in the real economy before we increase our corporate credit market exposure. There is still value in the banks and have just picked up a credit linked note with exposure to the R186 SA government paper at Jibar plus 210 bps, which is a great asset to have and shows the opportunities within the banks.
Maturity profile: Core Income Fund
We continue to be relatively conservative with more than 50% exposure in less than 1 year and 1-year plus instruments. We have reduced our short-term high levels of liquidity and are buying assets out into the 3 and 4-year area where there is value.
Quality of underlying instruments
Liquidity is not just about the levels of cash held, but more importantly about how liquid the instruments in your portfolio are and how easy is it to liquidate them in a crisis. The Corporate, Money Market and Core Income Funds all have high levels of exposure to negotiable certificates of deposit, which in our view are by far the most liquid and tradable assets to hold, having weathered previous crises well, as well as from a risk-reward perspective. The money market funds also have good exposure to Stepped Rate Notes, where the longer you hold them, the higher the rate in terms of the spread you get. After 5 years, you could potentially sit with Jibar plus 150 bps, or more, for a 3-month asset.
Rate outlook and inflation
The forward rate agreements (FRA) are the best indicator of whether there are going to be rate cuts, regardless of what the SARB says. The FRAs are now pricing in a 93% probability of a 50 bps cut in the repo rate over the next nine months with a high probability of a rate cut in July and another 25bps within the next six to nine months. Inflation dropped to 3% in April 2020, its lowest since June 2005. This is intuitive given the poor economic growth, no inflation globally and a lot of quantitative easing. We’re now in a completely different environment. The world sees higher country risk in South Africa than in Brazil for instance, as reflected in the higher spreads on our credit default swaps and higher yields on our long bonds, compared to them.
We are less convinced that inflation is going to be low for longer. We believe that the short end of the market will pick up and cash rates will start picking up after a certain amount of time, if and when higher inflation starts to become apparent. A lot will depend on what happens to the Dollar and oil price over the medium to long term. We know that substantial electricity price increases are coming and will remain high for an extended period, and we also have municipal budget shortfalls, so we’ll need to watch the impact on the cost of rates and services. We’re not seeing a drop in public sector wages, so we’re going to have continued high government expenditure versus a severely reduced level of tax revenues. Governments around the world, including ours, are printing money and we believe there might be more pressure on inflation going forward as a result.
ESG (environment, social and government)
We can’t continue as a society, to chase returns without taking an interest in, and responsibility for what happens to that money in the background. As asset managers, with the volumes of money we look after, we have a huge amount of influence on what types of business practices we support and invest in. We cannot just invest in pursuit of the highest yield regardless of the consequences on society. In the future, we may see a focus towards excluding or reducing exposure to certain entities if they are not prepared to operate responsibly. We are responsible for influencing change for good, to create awareness and to use our power wisely for the future.