Quarterly Commentary - Q1 2019

Fund Profile

The objective of the Granate SCI Money Market Fund is to provide investors with a way to participate in a diversified portfolio of money market instruments that ordinarily are either not available or offer a lower yield to retail investors. The primary performance objective of the portfolio is to obtain a high level of current income as is consistent with capital preservation and liquidity. Capital gains will be of an incidental nature. The portfolio is managed in accordance with CISCA and Regulation 28 of the Pension Funds Act. The portfolio will be allowed to invest in listed and unlisted financial instruments (derivatives) as allowed by the Act from time to time, in order to achieve the portfolio’s objective.

This is an ultra-conservative portfolio that caters for an extremely low risk tolerance and is designed for minimum capital fluctuations and volatility. It carries a short time-frame for investment. There are no growth assets in this portfolio and it is a cash-based investment. The ultraconservative portfolio aims to yield returns that are higher than bank deposits and typically higher than inflation. Capital protection is of prime importance.

The portfolio is bound by the exposure limits as per the ASISA fund classification structure applicable to South African – Interest Bearing – Money Market Portfolios. Money market instruments with a maturity limit of less than thirteen months, the average duration of the underlying assets may not exceed 90 days and a weighted average legal maturity of 120 days.

Economic overview

Economic growth in most regions is expected to have peaked, and consensus forecasts are for a mild slowdown. However, leading market indicators have started pointing to an increasing risk of a slowdown and possibly a US recession this year with other large economies also slowing down. Global inflation appears to be at cyclical highs which are well below longer term averages and recent inflation data releases have, on aggregate, surprised on the downside together resulting in major central banks slowing the pace of monetary tightening and communicating a more dovish message.

Domestic economic growth in 4Q18 (released in March) slowed to 1.4% q/q seasonally adjusted annualized rate (saar) from 2.6% in 3Q18 to register a full year expansion of 0.8% (1.4% in 2017). The mining sector remained the biggest detractor in the quarter and for the year while Gross Fixed Capital Formation (Investment) fell for a fourth consecutive quarter. Available data for 1Q19 continues to point to softness in the local economy as the mining and manufacturing sectors remain weak and car sales decline. Leading indicators such as the PMI’s and business confidence are depressed. Electricity outages now pose a very significant risk to the economic growth outlook and growth for 2019 can easily be shaved by 0.5% resulting in 2019 failing to beat the weak growth registered in 2018.

The Monetary Policy Committee (MPC) of the Reserve Bank met twice during the 1sᵗ quarter and kept the repo rate unchanged at 6.75% – a unanimous decision in both meetings. The March decision was accompanied by the most dovish statement delivered by the MPC in a while, saying that “The overall risks to the inflation outlook are assessed to be more or less evenly balanced” – the first time in 6 meetings that it does not consider the risk to be on the upside.

Both core inflation and growth forecasts were revised downwards for the next three years and inflation expectations (measured by the BER) fell meaningfully, albeit remaining above the middle of the inflation target of 4.5% – something that the SARB is determined to achieve. The downward revision to the SARB’s growth forecast was the result of the “bigger than expected slowdown in the global economy, declines in business confidence, potential supply side disruptions from load shedding and growing pressure on household disposable income”. We consider it unlikely that the SARB’s growth forecast of 1.3% for 2019 will be achieved.

The MPC considers the current policy stance to be accommodative and the SARB’s Quarterly Projection Model (QPM) is forecasting 1 rate hike in 2019. It is difficult to see the need for further monetary tightening given the weak performance of the economy. However, given the SARB’s determination to get inflation expectations down to 4.5% we believe that a rate cut is very unlikely in 2019.

Market overview

After a shaky end to 2018 financial markets recovered in the 1sᵗ quarter of 2019 with all major asset classes recording a positive return. Despite the recovery, money market assets are still outperforming all other domestic asset classes over a rolling 12-month period and continue to offer positive real returns.

Money market rates had largely reversed the upward trend experienced in the 2nᵈ half of of 2018. The 3-month Negotiable Certificates of Deposit (NCD) rate bucked the trend and ended the quarter 1.25 bps higher at 7.13%, while the 12month NCD rate ended 12.5bps lower at 8.225%(Q4 2018: 8.325%). Money market rates were slightly more volatile than the previous quarter with the 12month NCD trading in a 17.5-basis point range as compared with the 12.5-basis point range seen in the previous quarter.

The money market curve flattened further during the quarter as both economic growth and inflation remain subdued and the market priced out further repo-rate hikes. The gap between what the market is pricing in for the repo rate path and the SARB’s Quarterly Projected Model (QPM) widened further – the market pricing a slight probability of a 25bps rate cut by the end of 2019 compared with the QPM’s 25bps rate hike.

Portfolio activity

We started the year with a higher ratio of floating rate to fixed rate money market assets as result of the investments made during 2018. This ratio did however diminish as investments were concentrated in longer duration fixed rate assets which offered positive risk compensation.

This strategy employed at the beginning of the quarter was appropriate as investment into the 12-month NCD was attractive, given the return profile of the fund. While we didn’t actively increase the floating rate notes exposure, the yield provided positive uplift to the fund as bank funding rates remained relatively attractive and 3-month Jibar rates remained unchanged.

Portfolio positioning

At this stage the fund still has a slightly higher exposure to floating rate bank paper. The future benefits of having the higher exposure has moderated if the reserve bank follows the market predictions and decreases the repo-rate at future meetings.

Given our view that a repo-rate cut is unlikely in 2019 we will not be looking to actively sell our current holding of floating rate instruments. We will instead continue to follow our current strategy of decreasing the floating rate notes by reinvesting any maturities and cash holdings into longer term fixed rate assets which are offering positive risk compensation.

The money market portfolio maintains a high level of liquidity through call deposits and bank paper.

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Written by Vaneshen Naidoo

Portfolio Manager

Vaneshen joined Granate Asset Management in December 2015 and currently manages the Money Market and Cash portfolios in the Fixed Interest Team. He joined Cadiz Asset Management in 2006 as a graduate and during this time analysed the credit and property sectors for the fixed interest and multi asset class teams. Vaneshen holds a BSc. Hons (Engineering) and M.Sc.(Engineering) from The University of Cape Town, and is also a CFA.

CFA ®
M.Sc. (Engineering) (UCT)
BSc. Hons (Engineering) (UCT)