Quarterly Commentary - Q2 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

Uncertainty around global economic growth momentum, concerns relating to trade tensions and the possibility of slower global trade translated into dovish comments by both the European central bank (ECB)and the US federal reserve (FED). Both central banks referred more openly to the prospect of policy loosening if growth risks materialise and follow a wave of central banks that have either adopted or alluded to monetary policy easing.

Domestic economic growth in 1Q19 (released in June) came in a lot worse than expected at a seasonally adjusted annualised rate of -3.2%, the worst contraction since 2009. The contraction was broad based – agriculture, mining and manufacturing sectors deteriorating the most – suggesting that the cause of the slowdown is not limited to electricity outages. Leading indicators such as the PMIs and business confidence remain depressed and available data for 2Q19 continues to point to softness in the local economy as the mining and manufacturing sectors remain weak and car sales continue to decline sharply. That said, the electricity supply has stabilised, and the softness does not appear to be as severe as 1Q19. While a technical recession (which brings with it negative sentiment) will probably be avoided, the lowered GDP growth forecast for 2019 of both consensus and the SARB might be difficult to achieve. The Monetary Policy Committee (MPC) of the Reserve Bank met once during the 2nᵈ quarter and kept the repo rate unchanged at 6.75%. However, the vote was much closer than previous meetings with two of the five members voting for a 25bp cut.

The MPC revised its headline and core CPI inflation forecasts lower across the entire forecast horizon. CPI forecasts are now only slightly higher than the mid-point of the inflation target of 4.5% over most of the forecast horizon – something that the SARB has been determined to achieve. There was also further downward revision to the SARB’s growth forecast for 2019 which is now expected to average 1.0% (down from 1.3% in March) because of the larger than expected slowdown in the first quarter. The MPC now expects a materially wider output gap than previously envisaged, due to the disappointing 1Q GDP. A wider output gap and a lower inflation trajectory, which is closer to the mid-point target of 4.5%, are reasons that the Quarterly Projection Model (QPM) now embeds one 25bp cut by the end of 1Q20, as opposed to the March 2019 forecast which had one generated hike by the end of 2019. The inflation trajectory and an MPC that sees the balance of risks around its inflation projection being more or less even, provides room for a rate cut and cyclical support for growth without comprising its main objective or credibility.

We therefore believe that rate cuts are very likely in the 2nᵈ of 2019 with the risk of rates remaining flat if Eskom’s challenging financial situation (and the knock-on consequences this could have for South Africa’s fiscal position, credit rating, and exchange rate) cannot be resolved.

Market overview

Financial markets had a 2nd consecutive positive quarter in 2019, buoyed mainly by dovish central banks and despite generally softer economic data in both emerging and developed markets.

Locally, all major asset classes recorded a positive return. Despite the recovery, only the local bond market (ALBI) outperformed money market assets over a rolling 12-month period. Money market rates fell in May following on from the SARB’s dovish MPC statement. The money market curve also flattened further during the quarter as both economic growth and inflation remain subdued and the market priced further repo rate cuts.

At the end of the quarter, the market (as proxied by the Forward Rate Agreements – FRAs) was pricing in a 25bp rate cut in July and a 50% chance of a further 25bp cut by the end of the year. As a result, Negotiable Certificates of Deposit (NCD) rates at quarter end had declined. The 3-month NCD rate decreased by 6.25bps, while the 12-month NCD rate ended 48bps lower at 7.75% (Q1 2019: 8.23%).

Portfolio activity

At the start of the quarter the money market fund had a higher ratio of floating rate to fixed rate money market instruments. We continued to follow a strategy of decreasing the floating rate notes by reinvesting any maturities and cash holdings into longer term fixed rate assets which were offering positive risk compensation. This strategy, employed at the beginning of the quarter, was appropriate as investment into 12-month NCD’s was attractive, given the steepness of the money market curve and the return profile of the fund. Floating rate notes provided positive uplift to the fund as bank funding rates remained attractive and 3-month Jibar rates remained relatively unchanged until June, at which point we started to sell our shorter dated floating rate notes when liquidity was needed.

Portfolio positioning

While the fund has a slightly higher exposure to floating rate bank paper, the future benefits of these type of notes have moderated and could weaken further if the reserve bank follows the market predictions and decreases the repo-rate at future meetings.

Repo-rate cuts are likely, but the market has already priced in a high probability of these cuts into fixed rate notes. The money market curve is no longer as steep as the previous quarter and the risk compensation, while positive, has decreased. Bank funding spreads are still, however, elevated and there is some risk that the repo- rates will not be cut as aggressively as the market has priced in. We will therefore to look to invest into longer floating rate notes at this stage.

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)