Fund Fit

Speaker 0:
Hello and welcome to this fund fit session. I'm joined today by Rafael KOMO, chief investment officer at Qanta Investment Holdings.

Speaker 0:
Megan Bellinger, research analyst at Analytics Consulting as well as Ivan Rogers, Financial Advisor at Efficient Wealth. Welcome to you all. Thank you. So today, discussing income funds. Rafael, I'm gonna kick off with you. Perhaps you can take us through your range of income funds at a quanta and what the investment objectives are and which types of clients these funds would typically be appropriate for. Thank you for inviting me,

Speaker 0:
Uh, maybe a word about Qanta first before we delve into the income solutions that we provided to Qanta. So the is the probably top two black asset management firm by a UM. We we we have about 250 billion in in assets on behalf of our clients. Um, and then we run a range of solutions. So from cash to call it equities. But we

Speaker 0:
we tend to offer solutions. We have a cash solution, an income solution and what we call rule based solutions which are mostly passive or, uh, systematically active solutions. Um, so in the income space, specifically, we we offer three solutions at three funds or solutions. Three strategies at the

Speaker 0:
the one is the, um, stable income, which is a a primarily domestic or run based, uh, income fund with no volatile asset like, uh, shares or pro properties. We do have an active income fund, which, which is in the multi asset class income categories of a I A uh and then we do a full range of asset allocation decision within the income permissible asset within the income space. And then we have an enhanced income fund,

Speaker 0:
which is, uh, a credit play over the long term. So there we do, um, unlisted dates and and all of these other things. So specifically the active income fund that we we are discussing this morning. I think it's very suitable for clients who want capital protection over the short term. And then they want capital growth over the medium to longer term. So we target um

Speaker 0:
uh about 100 and 10% of as as a benchmark. And then we we use a wide range of asset classes to to to navigate, some of which could be, you know, vanilla credit and others are like structured credit where we engage with the banks and and put those assets in the book.

Speaker 0:
I hope that gives you a flare. And what's the active income fund? Absolutely, Absolutely. So this Active Income fund Is it appropriate more for institutional investors? Or is it more for the retail market? It's for both. So we do have a fund,

Speaker 0:
which is a CAA unit trusts in that space, where we run a lot of segregated accounts for institution for institution clients. So it's really suitable, for generally it targets a.

Speaker 0:
We target a sustainable, high and sustainable yield. We want capital protection, and we want some liquidity. That's really what determines our active income fund.

Speaker 0:
And and as it stands, I think the yield is well above 11% so and with minimal duration. So I think client can reasonably expect a return around 11% in one year's time, with very low level volatility. OK, we'll go into the, um into the investment process a little bit a little bit later. But, Megan, I want to bring you in here from AD FM angle. How would

Speaker 0:
analytics, uh, typically make use of income funds in general? And how would you perhaps integrate the use of SSA's active income fund into certain solutions. Um, at analytics. Um,

Speaker 1:
thanks so much for having me, Chloe. Um, so, first of all, you have to

Speaker 1:
start with, um, the crux of it that not all income funds are equal and you have to look to the foundation of what it is built from and how that ties to what it's trying to achieve. So take the investable universe, for example, um, Rafael highlighted some of the classes that they would go into, um, and whether it's a structural allocation to government bonds over the long term, the next fund might have no allocation to government bonds at all.

Speaker 1:
And then again, to what it's going to achieve. A lot of income funds have very specific and explicit risk objectives. So whether that be, um, a need for liquidity avoiding capital loss over a certain rolling period. And on the other hand, others might target more capital growth and actually a higher real return. But in reality, most income funds target both as Rafael also mentioned with Active Income fund.

Speaker 1:
And it's just about knowing which one they tilt or lean more toward when doing the analysis. And if we look at the CS a fund category, um, there are over 1 21 30 funds. So it first, firstly shows that it's a very popular investment vehicle for clients, be it for yield enhancement for capital protection. But also, you can only imagine the wide variety of the type of risk and return profiles you're gonna get from these income funds going forward.

Speaker 1:
So, Asset Analytics, um, we do have two, model portfolios, a local fixed income model portfolio, as well as a global, um, fixed income model portfolio that are available to use by advisors.

Speaker 1:
And then we also have a preselected, um, list of funds that have we've been through the investment due diligence process. So it's past that, and it's cost effective. And then these can be used as a tactical building block in an overall model portfolio to either lower the risk profile of the fund or enhance the yield in some way. And this can be done as part of our core range or in any bespoke model portfolios. OK,

Speaker 0:
so you mentioned the due diligence process that takes place. Perhaps you can take us through some of the qualitative

Speaker 0:
of aspects that you do look at when, um, selecting a manager?

Speaker 1:
Sure. So, on the quantitative side, um, we run a number of screens and a number of metrics that cover both the absolute and the pure relative side of things. We look at consistency. We look at the success rates of achieving a certain hurdle, be it a, um a real return, um objective, for example, or in terms of avoiding capital loss over certain periods and so on.

Speaker 1:
Then at analytics, we believe that diversification is a very important part of a successful investment. Um, strategy. So we look at the correlation between the different types of income funds, and, um, try and blend these and balance them in the most optimal manner.

Speaker 1:
Then when it comes to risks so over and above the kind of the likes of avoiding permanent capital loss, we also examine the risks that are very closely associated with fixed income investing. So, for example, if you take a look at interest rate risk, how much duration or what range the duration plays are of the fund or the default risk when it comes to the type and the amount of credit that's also in the fund. So these are all very important factors to look at

Speaker 1:
and then also on the qualitative side of things. So we like experienced managers and they must have a consistent philosophy that they execute. And the process must be evidence to us that it's robust. It's reliable, and it's going to be able to be repeated going forward into the future. And the best way for us to do this is to do ongoing, ongoing engagement and ongoing monitoring with the asset manager so we can find its most suitable use in the overall portfolio.

Speaker 0:
OK, thank you very much.

Speaker 0:
So, Rafael man, I bring you back in here. Perhaps we can delve a little bit deeper into the Active Income fund at SQA. What defines Swan's active income fund and how is it differentiated from other income funds in the broader South African

Speaker 0:
bought a South African market.

Speaker 0:
It's a difficult one is in a in a universal way. You have about 100 and 30 plus fans. Um,

Speaker 0:
I think at we we have a history of managing income fund. So if you if you look at, uh, we primarily a fixed income house with some equities and balanced funds. But the root side to is fixed income. So we we have a track record in managing those those those instruments, Um, in our in our previous life, um, my own previous

Speaker 0:
life and experience, I did manage A I was part of a pretty large active income fund in the country. So we know what to do and what not to do in the income space. So what determined to Qantas Active Income Fund today is primarily, uh, the way we look at the universe of permissible assets. So you have the

Speaker 0:
the very vanilla credits and that that plays an important role depending on the on the economic cycle. And then you have to look at, let's say the structured credits and then your your interest rate view or the direction of interest rate must determine which one plays it together with, Let's say credit spreads. What we've seen in the recent past is that credit spreads are very narrow and and the reason for that is, you know, the economy is not growing,

Speaker 0:
and then you have, and then you have a sizable pool of assets in the retirement industry. So corporate are using that to price very close to bank paper. So,

Speaker 0:
um, if I have a choice between a corporate and a bank, I will start with a bank unless the corporate provides a significant year pick up relative to to a bank paper. So what we've done to Quanta is that for the past five years or so, I think we shy away from vanilla credit simply because it doesn't offer that much value. You taking a lot of risk and you're not getting, uh,

Speaker 0:
a significant pick up for the risk that you're bearing. So we have focused a lot more on structured credits where we work with the banks and try to have bespoke structured

Speaker 0:
product in the fund, and that has worked very well with very determined outcomes. I think if you ask me, the one thing that makes the Quanta fund different from the other fund is really that ability to make big decisions, whether we we have a blend of structured and vanilla credit or which is structured credits

Speaker 0:
primarily or or vanilla credit. So we we navigate that. But within the the vanilla credit or the structure credit there's a lot of things one can do in the income space. OK, I think the perception that equity offers you more diversification is probably not very true because, uh, fixed income has more diversification.

Speaker 0:
The the the opportunity set is much wider, But you have to be very creative because you don't have a market where you can just go buy in an exchange. It's something you have to work with the bank and structure those things before you put them in a fund. So we've done that. We've done that quite well.

Speaker 0:
Call it 2019, 2020. I think we haven't had a lot of vanilla credit, but there is space for that. We will monitor the market. We will add those in instrument when the market dictates. So so So I think the the way we really, uh, we we do have a

Speaker 0:
a team of credit analysts, but they manage a separate fund so the active income fund can navigate structured and vanilla credit, and there is no limit beyond what the regulation imposes. And when I'm in regulation rate 28 and CS beyond that, we tend to be quite flexible in how we look at this thing. So I think we

Speaker 0:
we are monitoring the space. We think that there will be space for credit, but we strongly believe that yield have got to move up first before they move down. So, Ivan, perhaps I can bring you in here. What is it, then, that clients or advisers would need to take into consideration when

Speaker 0:
looking to allocate to to an active income fund? And I believe it might be a little bit more highly, highly rated on the risk spectrum than, say, the Stable Income Fund. I think the most important role you know, that that we play in that decision would be risk versus reward and where, how long the client needs the money for So when when looking at term, you're looking at, uh, especially in cases where clients are retiring.

Speaker 0:
Uh, and they've got a pension fund that needs to go into a specific product and pay them an income for life. That's when we start looking at which funds how much risk are they taking full term? So

Speaker 0:
we from from my planning perspective, I always look at a silo approach which in in short, and simplistic ways. It's a short, medium and long term diversification of the funds. Uh, and income funds play a large role in that because,

Speaker 0:
uh, you want to select funds in the short term, um, approach that are very low risk and can give you results. Um, you know, in the next year can give you results over the next five years. And a lot of portfolio managers, uh, usually only focus on on the three year return cycle. We are quite like their fund, is

Speaker 0:
it? It gives the the liquidity option for the next three months. Six months? Because that's what's the most important to a client, is they? They They trust that you're doing your job over the 10 year, 20 year period. But where they actually care is, are they gonna receive an income next month? Are they gonna be able to pay their bills next month from their investment? So

Speaker 0:
that's where I've seen your investment be a very good option. Thank you very much, Ivan. Now, Rafael, I kind of want to understand now in managing this active income fund, what flexibility are you allowed? Perhaps on the duration spectrum or on the credit spectrum or allocations to property and and, um, other income assets.

Speaker 0:
What is the type of flexibility that you committed? I think the you you have to think first about what we're trying to achieve with our income fund. I think we you're playing an income fund with two or three basis point a day.

Speaker 0:
OK, that's really what you have. And if you annualize that comes out to anywhere between nine and 11% so that so if you put in any volatile assets, then you can. You should be prepared for daily drawdowns. And that can be a problem if a client expect to draw income from that fund on a monthly basis.

Speaker 0:
So you then have to decide. How should I mix the volatile assets when I mean volatile asset is Vanilla Bonds shares properties with the more floating rate bonds and fixed rate bonds and so on. So you have to have that balance quite right so that you have sufficient capital growth over time, but with

Speaker 0:
very little draw down. So in that sense, um, the limits the duration limit, for example, in the fund is two years so we can go up to two years, but we've never been since inception at 0.5 years because we shy away from adding a lot of duration in the fund that can increase your yield. But then your yield can no longer, um, give the client an expectation of return because you're having a lot of interest rate duration.

Speaker 0:
So we want to tell our clients that if we say 11% yield, we most likely going to translate that into 11% returns. But that's not true. You can only do that if the duration is very low. So right now our has about 0.3 years duration.

Speaker 0:
We're probably gonna add a bit more duration as our interest rate view come to play, because we believe that we're probably at the top of the cycle. Uh, how long we're gonna be there? We really still to be determined, but from here, probably gonna be the next move down. And in that sense you want to add a bit more duration in the fund.

Speaker 0:
But you have to be very careful. So the limit the limit that the regulation permits you have a bank limit. You know how much you can expose yourself to one single bank. You have the limit in terms of what asset universe that you can invest in. You have a limit in terms of duration, which I said is maximum two years. You have limits

Speaker 0:
terms of offshore, so we typically will hedge everything. So we will go offshore. But we want to take naked exposure. So we hedge back everything in rams so that we have an equivalence where it's a R for R kind of exposure. So the limits are really guided first by

Speaker 0:
the client, the regulation, the prevailing regulations. They are also guided by the mandate specific limits. So you have to balance that in terms of rating instruments, you have to be within the investment grade. Primarily the non rated kind of ratings in terms of the funds are very small. We tend to shy away from anything that is not investment grade. And if you look at the fund rating,

Speaker 0:
aggregate is about AA. So we don't take a lot of, uh, credit exposures which are not investment grade. OK, thank you very much for explaining that to us. So, um, Ivan, and perhaps, uh, Megan, you can comment, um, two specific client scenarios that the active income fund would be appropriate for. And perhaps we can look at the some of the solutions from AD FNS angle

Speaker 0:
that perhaps might, um, cater to these two clients. Um, so I think, uh, very much in the in the post retirement space. Um, you know, we've spoken before. It is a regulation 28 compliant fund. Um, so you can use it in in pre retirement in the years coming up to retirement, where a client wants to take a lot less risk just before they retire. But in the post retirement space. And you're using the

Speaker 0:
a silo approach where the models obviously come in play and you you're putting it in the short term space where a client can draw an income for the next year 2 to 6 years. I've I've seen it very useful in that space. Another space where I think, um, it's very helpful is with companies. So so companies or maybe individuals that receive funding and want to to use it for a project over the next 3 to 5 years. Often they do that budgeting on,

Speaker 0:
um, you know, the five year period, but things other external risks, like, um, trade agreements or, um, something going wrong in a project they need maybe more money or they just need some money to, um they need the money to grow and last So the first the first

Speaker 0:
for for, uh, an individual or a company when they receive funding is go and put it in a banking product and try and get something out of it. But they need liquidity. So these these active income funds are ideal for that. The returns are a lot better. They're often a lot cheaper. And you've got

Speaker 0:
analysts that are constantly looking like you said they use banking products a little bit as well. So they're looking at, you know, the various options that are out there. So I've actually I've seen it be quite effective for something like that. Where where you need money, you need an income for five years. Three years? Yeah. OK,

Speaker 0:
So, Megan, perhaps you can comment there with regards to, you know, the appropriateness of analytics solutions for say, for example, a post retiree or, um, a business. Um, that may need somewhere to park their cash, but that they have, um accessibility to.

Speaker 1:
Yeah, sure. So Thanks, Chloe. So, the, um, scenarios that I haven't painted are very good examples to show that again. One income fund might not be suitable for client X as the next income might, Um, fund might be for client Y, and it all comes down to determining the suitability of that fund. Um, and it's right use for particular clients, be it in a, uh, the the life stage that the client is in or for a particular need such as the project and so on. So

Speaker 1:
when we look at income funds as mentioned, we do have our part of our core range those, um, local and global fixed income model portfolios. But we do have the bespoke ones. And when analysing a fund such as the active Income Fund, it's up to us to determine

Speaker 1:
where it will be suitable to use so across the spectrum from the end of a very unconstrained, flexible, um, lots of duration flexing type of income fund all the way to the other end of a very steady, constant yield, um, generating fund where a very high liquidity need.

Speaker 1:
It will probably be be more suitable for and again it comes back to both. What Rafael and Ivan have also said is, what is that objective? What is the fund actually trying to achieve that we can be in a in a position as allocators to fairly and appropriately assess the fund and whether it's going to achieve on its mandate and when it may not.

Speaker 0:
So then, Rafael, from an investing perspective when you're managing this fund, what are the risks that you're trying to control for? Of course, interest rate risk is one of the most important, if if not the only risk that you're trying to, um, account for. But you mentioned credit risk. And even though you do have a very small, um, exposure to credit currently, if I'm not mistaken, what other risks are you? Do you do you try and navigate

Speaker 0:
income funds are there's a wide range of risk. Um, duration is just one of the risk, which is roughly your interested risk. Um, credit risk. You know where, um, I? I mean, the

Speaker 0:
probably need to clarify that even when you have a floating rate bond, you still have some risk because you have a spread risk, you don't have the duration rate, but you still exposed to spread risk. You have liquidity risk. You have operational risk. So these things are sometimes

Speaker 0:
quite complex instruments, so you need to be able to report on them and price them and value them and administer those things. So there is a wide range of risks and therefore there is a careful balance between what you're trying to achieve, what yield you're gonna pick up with a fair amount of liquidity. We give, let's say, monthly distributions so

Speaker 0:
I can go in a in a space where I don't give income back to the client on a monthly basis, because that's what the the fund is positioned to to achieve. So we we watch a lot of risk. But even when you talk about interest rate risk, but there is a lot of macroeconomic factors behind interest rate rate, so that you need to assess and

Speaker 0:
and then perhaps you still have currency risk if you going offshore and then you hedge and so on. So there is a wide range of risk that income income funds will will will expose the client, and it's very important, critically important to

Speaker 0:
to monitor those risks and manage them carefully. I think interest rate rates we. We tend to take a view on the direction of interest rates. So we're not good at giving a view on, Let's say interest rate will be 8.25 you know, or 8.5. We just don't have an idea. The N PC will set interest rate. We don't know what

Speaker 0:
they do, but we can have a sense that interest is going up or down. And once you have a sense of interest going up or down, they are instruments that are good for rising interest rate. They are instruments that are good for falling interest rate. We saw that during the covid when interest rate crashed to about four or below four. If you had an income and you're earning jaba plus, call it 100 or 150.

Speaker 0:
You know you will earn 5.5, Um, and that makes a huge difference in in in the Client, the client portfolio. So we assess all of those risks and be proactive. You have to anticipate what could be a risk in the fund and then try to manage that ahead. of and certainly South Africa has

Speaker 0:
very low history of default. Uh, but that is history. And going forward, uh, the probability of defaults are certainly gonna gonna rise. Because if somebody was funding, the business at 4% is going to fund the business at nine. And that makes a huge difference. And those who are coming into business now they have to

Speaker 0:
live with, Call it 9 10% to fund their business. And that put a lot of pressure in the balance sheet. And we've seen recently some companies going under severe strain because you're gonna have defaults and that start with consumer default and that might go into business. So you have to monitor those things and know how much you're getting paid for the risk that you take.

Speaker 0:
Um, you did mention that you do employ certain instruments to capitalise on upward and downward, um, interest rate moves. So with the probability that future interest rates will be declining,

Speaker 0:
are you making use of derivatives such as options for, uh, futures forwards? Um, considering the illiquid nature of of the bond market.

Speaker 0:
So So right now, our view is, um, first of all, when you design an income fund you never all fix or all floating

Speaker 0:
because you don't know. OK, you you have to be pragmatic and always

Speaker 0:
against unforeseen circumstances. Even when you go into a rising interest rate, you want to have a lot of floating rate instruments. But because you don't know when interest will actually plateau and start coming down, then you have to start adding some fix in the fund. So our primary instruments going to falling cycle will be invest Flo, for example, and those invest floaters are nothing different from, say, a fixed minus

Speaker 0:
java, for example. And then as Jaba falls, the spread between the fix and Java increases. Therefore, you get more yield in the fund. So we are putting those instruments in the fund. You can't wait for too long because waiting is going to be. At some point, the curve will invert completely and there won't be value in this thing, so you need to anticipate those those kind of moves before they occur. So we started putting some fix in in in the fund,

Speaker 0:
but we still have a fair amount of floating. So even when we are confident that interest rate eventually will fall and can fall a lot. We won't go and put all of the clients asset into fix into fixed interest rate instruments. You will still have to have some floating. Just that the balance changes where you have more floating. You have more fix and

Speaker 0:
and be prepared as well, because interest rate will bottom and go, and the interest rate will go up and be prepared to change. But remember, these instruments are not liquid, so you can't just There's no market for those instruments where you can just go and liquidate them and then shift your portfolio in one direction or the other. So you have to be extremely careful. Um, but the good news about um in interest rate instruments is that they mature. So you have regular coupon, and then you can then redeploy that coupon. So you still have,

Speaker 0:
uh, in terms of risk reinvestment risk. OK, so there is a lot of risk, uh, in in, uh, income. Yeah. So it's interest rate risk, reinvestment risk, depending on which direction interest rates are expected to go. So, um, a very interesting discussion discussion indeed. And perhaps we can unpack this hopefully sometime in a master class. Um, but, um, Ivan, perhaps we can and Megan, you can. You're more than welcome to come here as well,

Speaker 0:
just to close of the session. Now, are there any further considerations that needs to be taken into account when you know, considering an active income fund instead of a stable income fund or any income fund in general from a client perspective, um, that they might perhaps not be aware of? Yeah, most definitely. I, you know, clients are always very prepared to when they're looking at comparing funds. So they always prepared to take a lot of risk because that tends to lead to more reward. Uh, until they start losing

Speaker 0:
and and that that has always been. And then then we have to answer the question. Why why are we losing? And it's because you've taken so much risk. So what I what I've noticed with income funds? Um, is it the approach has to be it. It's so like you said, it's so minute. The difference in what? What could the end result be and where your where your funds tend to stand out for me is that it's so focused on the next 3 to 6 months.

Speaker 0:
And that's phenomenal because we've got so many economic factors, you know, leading up over the next year that we all talk about and that we are concerned about. I mean, we we talk about, um, the elections coming up, What effect is that gonna have on investments? Um, but with with your type of fund, clients are still guaranteed that security of the income that's looked after in the next month, they don't have to worry about what's happening in 18 months. They worried about

Speaker 0:
what's happening in the next month to three months, and they know they'll have that security of still getting an income. Um, still getting the return on their investment. And then being an active manager obviously stands out that you you're looking at it also a little bit in the more longer term to give them the results. So it's it's nice. It's a good balance because we we know that you've got that that sure short. But then,

Speaker 0:
uh, you know, 24 months later, you you You do have your mind on that as well. So, Megan, any closing thoughts for you? Yes.

Speaker 1:
Thanks. Chloe. so completely agree with what's been said beforehand. And as we've established, there are many risks. There's never no risk. And even in the income category, which you think is one of the lower risk categories, there are risks. It's risks that we see across equity other multi asset funds, but also fixed income specific risks, too.

Speaker 1:
And as Rafael mentioned, it's about blending different types of fixed income instruments to mitigate that risk as far as possible. It's also our job to then blend the different types of income funds to mitigate that risk possible. And we've heard a few macroeconomic views, UM, today. But it

Speaker 1:
it's also important to integrate that into the process when assessing different managers. Because we know different managers have completely different views of where we are, say, in the interest rate cycle or which way inflation is headed, for example, and this can also dramatically affect the the funds positioning too. So it's important to consider that so

Speaker 1:
one of the um, points that is so important when assessing fund managers and in income funds is the manager should be experienced in managing money over a meaningful time period. So yes, an objective might only be for 3 to 6 months, but we want to see that they've been able to say, manage it over the full interest rate cycle so that again we can assess them properly. Um, and that's a very important factor to consider.

Speaker 0:
OK, well, on that note thank you very much to all of you for sharing your insights. We sincerely appreciate your time. Thank you. Thank you very much. Thank you.