Bonds: Piling into capital markets
There is a lack of sufficient issuance to meet investor demand as balanced and hedge fund managers enter the fray
We are approaching the 10th anniversary of the collapse of Lehman Brothers in New York and the trough of the global financial crisis.
It was a point when corporate and parastatal bonds or credits couldn’t be given away.
But it was also a good point to climb into the credit market. Victor Mphaphuli, manager of the Stanlib Flexible Income Fund, says investing in credit is now one of the key techniques of fixed income investing.
In SA there are few pure credit investment vehicles, but institutional investors in the Investec Credit Opportunities Strategy will be smiling.
There has been a total return of 11.7% a year, a 5.1% premium on three-month cash rates.
Fund manager Simon Howie says that 10 years ago spreads, or the extra yield compared with money market rates, averaged 7%. This has narrowed to 4.2% in SA. It is not for everyone, as just 10.5% of the fund is exposed to AAA paper and about 30% to BB+ or lower, or subinvestment grade, sometimes called junk status.
With new issues of R120bn a year over the past decade, the nonsovereign or credit sector now forms a significant part of bond and income unit trusts. Up to 45% of each day’s trade in the fixed income market is now in credits. If the market is working efficiently the spread should reflect the risk of default, and less liquid bonds would be expected to pay a premium.
There won’t be the same variation in rating that characterises the equity market; spreads will be similar whether it is Absa or FirstRand paper, for example.
The main concern for a bond owner is the risk of insolvency, which is negligible under the banks’ current capital regime. The owners of SA credits are predominantly local investors, so the sector has not been as affected by the recent outflows by foreigners from the debt market, which has been running at R43bn over the past year.
But Futuregrowth portfolio manager Jason Lightfoot says there has been a lack of sufficient issuance to meet investor demand; an increasing number of balanced and hedge fund managers have entered the debt capital markets, leading to oversubscription at bond auctions.
"Further spread compression is expected given this dynamic, but it is not a reflection of improving credit profiles."
Mphaphuli says supply is drying up as the economy has slowed down, though at least banks will always remain active, with Absa the most recent issuer.
Parastatals, even if they do not have an explicit government guarantee, have implicit protection. It is unlikely that the government would let the Land Bank go under, particularly with the uncertainties in the agricultural sector. It is also one of the few competently managed parastatals and enjoys spreads of about 180 BPS.
"We want to support parastatals and municipalities more," says Howie, "but it is client money, not our own, and we have to exercise due caution."
Gareth Bern, portfolio manager of the Prudential High Yield Bond Fund, says the rebuilding of the parastatals has to take place, but in the long run they are highly capital intensive and should be regular users of the debt market. It helps that R350bn of Eskom’s R389bn of debt is government guaranteed. But in Transnet’s case, R18bn of debt is being renegotiated based on a qualified audit — even though Bern believes Transnet has generally better prospects than the electricity giant.
There are now 1,500 individual credits in which to invest on the JSE, but each bank might have 30 or more.
There are no specialist credit bond unit trusts, though they form the bulk of shorter-dated funds such as Investec High Income and Stanlib Income.
In Investec Credit Opportunities, about a third of the fund is exposed to financials, the main names found in the more vanilla income fund.
As well as the big banks there are names such as microlender Bayport, African Bank and Transaction Capital. Investec likes the steady income provided by cellphone towers across the continent such as IHS Nigeria and Helios Towers and airlines such as Ethiopian.
Howie considers non-SA government bonds as credits, and invests in bonds issued by the governments of Cameroon, Ghana and Kenya.
There is an unlisted (and unrated) bond sector focused on infrastructure.
The Futuregrowth Infrastructure & Development Bond Composite can invest up to 50% in unlisted instruments, and for efficient management keeps about a third of its assets in cash and sovereign bonds.
About a quarter of its exposure is to energy, through renewable energy as well as Eskom paper. Lightfoot says he is concerned that there has been a great deal of floating-rate paper (which reprices every three months along with short-term rates) issued in the listed market, which makes it difficult for traditional bond managers who prefer fixed-rate paper that can be clearly benchmarked against the all bond index. It will be several years, or even decades, before pure credit portfolios are introduced in the retail market — particularly if they have significant unlisted or junk holdings.
The Coronation Strategic Income Fund is rather modestly billed as an intelligent alternative to cash. More than half of the fund is invested in either fixed or floating corporate bonds.
Fund manager Nishan Maharaj says it focuses on quality issuers such as the banks and a few strong non-banks such as MTN and Growthpoint.