The Granate SCI Multi Income Fund is a domestic income portfolio which seeks to provide investors with consistent positive returns and minimal volatility. The objective of the portfolio is to deliver real returns in excess of money market and traditional income portfolios over the medium to longer term. Investors are primarily exposed to the fixed income and credit markets.

The portfolio aims to optimize risk-adjusted returns by strategically allocating within the various sources of the fixed interest and credit universe according to current valuations. The portfolio will optimize the yield of the portfolio whilst compensating as far as possible for the underlying risk. This is done by focusing mainly on credit and yield enhancing strategies, whilst very moderate duration strategies are employed. The portfolio is managed in accordance with regulations governing pension funds and CISCA.

Market Comment

Global Markets ended the year on a positive note as trade agreements were reached between US and China, while the UK elections delivered political stability which cleared the way for Brexit. Generally central banks continued their accommodative monetary policy stance and the overall positive sentiment spread to emerging markets including South Africa.

Unfortunately, local SA data released in December showed the economy shrinking by -0.6% displaying broad based weakness in the economy with only 4 sectors recording growth and most sectors in technical recession. The situation at Eskom will continue to contribute largely to these negative GDP numbers going forward, as South Africa was once again plunged into darkness over the quarter due to Eskom’s electricity generation fleet experiencing an unprecedented level of breakdowns. This low level of GDP enhances SA’s fiscal predicament as it forms the base of Government’s revenue. The Mid Term Budget published in October already highlighted a revenue shortfall of R48bn over the next 3 years and based on the latest GDP numbers and nominal economic growth falling to 3.8%, the future revenue shortfall could be significantly worse.

Due to positive emerging market sentiment, the Rand strengthened by 8.12% against the USD. Equity markets also recovered and were the best performing asset class for the quarter, returning 4.64%. Bonds and money market were on a par returning 1.73% and 1.74% respectively, whilst ILBs and Listed Property continue to be laggards largely due to benign inflation conditions and very negative growth fundamentals.

Portfolia Activty and Positioning

Our fair value model is showing that bonds are still cheap as the sovereign spread is pricing in a significant risk of a downgrade whilst global rates are at all time low levels risk. Although we are mindful of the fiscal risks which could impact the long end of the curve, we cannot ignore the fact that longer dated bonds are offering very attractive real yields, and in an environment where there are unlikely to be further rate hikes, and taking into consideration the relative value of government bonds versus credit bonds, it would be prudent to include some exposure. The multi income fund did not increase duration over the quarter, however we did find opportunities to invest in the longer end of the curve by asset swapping the R2030 bond. This enabled us to get exposure to the attractive government bond rates in the 10 year area of the curve without taking duration risk, effectively taking advantage of the very wide asset swap spreads. In the shorter area of the cure we favour Inflation Linked Bonds (ILBs) over nominal bonds and found some attractive opportunities in the secondary market.

We have been consistently improving the quality of credit, as well as reducing credit duration as credit spreads are at all-time lows and do not offer relative value against nominal bonds or ILBs. Over the quarter we further increased exposure to Government Guaranteed Eskom bonds as the relative credit spreads for government guaranteed credit versus local bank credit has widened significantly.

The fund achieved a return of 1.96% for the quarter which outperformed money market and bonds. The multi income fund continues to focus on achieving consistent positive returns by focusing on our credit process and diversifying appropriately, not taking binary duration bets, and avoiding repricing risk by not overpaying.