Corporate credit – a viable alternative to cash

Paul Hutchinson,Sales Manager at Investec Asset Management

Saul Doctor of JP Morgan, in a report titled What Your Great-Grandfather Should Have Bought: Analysing a Century of Asset Returns, came to the fascinating conclusion that on a risk-adjusted basis, corporate credit outperformed the other asset classes (government bonds, equities and gold) for the period 1919 – 2009.

There is no proxy index for South African corporate credit. However, given that corporates have generally issued debt at more than 160 basis points over Johannesburg Interbank Agreed Rate (JIBAR), this asset class has also delivered attractive risk-adjusted returns domestically.

How to access this asset class?
Very few corporate credit investment vehicles exist in South Africa, particularly for retail investors and those requiring daily liquidity.

However, Investec Asset Management has developed an enviable long-term track record of analyzing and investing in corporate credit on behalf of such investors. The Investec High Income Fund invests largely in corporate credit as it offers an attractive opportunity to maximize income and grow capital.

The Fund is a specialist fixed income fund that aims to deliver a low volatility, yet compelling and competitive high yielding alternative to traditional bond funds and cash.

The Investec High Income Fund offers access to investment-grade corporate credit and little exposure to duration, thereby cushioning the Fund’s capital against the impact of a changing interest rate environment. This is because the Fund typically invests in floating-rate notes, which offer a variable interest rate linked to money market rates.

Cyclical resilience
The focus on investment-grade credit, coupled with an active management approach, has yielded an offering that is designed to remain resilient across economic cycles. As a result, the Fund has the potential to deliver competitive returns on a consistent basis.

The application of this focused investment strategy has resulted in the Fund delivering consistent returns above cash and inflation through time.

Source: Morningstar and Investec Asset Management, since inception of the Fund’s A class on 02.04.00 to 31.03.17. Performance figures are based on a lump sum investment, NAV-NAV, net of fees, gross income reinvested, in ZAR. Highest annualised return: 16.1% (30.06.03) and lowest annualised return 4.3% (31.08.14) – 12 month rolling performance figures. The total expense ratio is 0.92% and the transaction cost is 0.01%.

Since inception, the Investec High Income Fund has outperformed its benchmark by 0.48% a year on average after fees, and by 0.87% a year since the change in benchmark on 1 July 2011.

A sound track record

Investment-grade credit refers to counterparties with a long-term credit rating of at least BBB-. The development of the South African listed debt capital market (DCM) has shown steady progress over the last 15 years.

A key feature during this period has been the evolution of the listed corporate credit market comprising predominantly investment-grade issuers. The listed DCM serves as an alternative source of funding for banks, state-owned enterprises and corporates.

As a proxy for investment-grade credit, listed DCM issuers have had a strong run, with the only real default giving rise to losses for investors being the curatorship of African Bank Limited in August 2014.

The South African experience should not be a surprise – the global experience bears testimony to the resilience of the investment-grade credit class.

Credit valuations and positioning
Given a more supportive global economic backdrop, we are cautiously optimistic.

There is a strong focus on stock selection, portfolio composition and liquidity management. We prefer defensive sectors with strong bottom-up fundamentals. Essentially, we seek to identify entities whose balance sheets are sound and that have good strategies in place to weather tough and uncertain conditions.

In conclusion, the Investec High Income Fund has an attractive gross running yield relative to cash of around 9.4%, with negligible duration risk. The team has been able to enhance the Fund’s yield without sacrificing on the quality of the underlying investment instruments.