2018 was a good year from a performance perspective. In the Fixed Income space, the funds I currently manage (Income, Bond and Hedge Fund) outperformed their benchmarks and ended the year close to the top of their respective categories.
The year started on a high-note, buoyed by the strong rally following the ANC elective conference in December 2017 – an upshot of a welcomed political change coined as “Ramaphoria”. Bonds started the New Year around fair value, while the Rand had already moved to expensive levels. As the rally continued in the first quarter, the Rand strengthened below R12/USD and SA 10-year bond yields lowered to around 8%. At these levels, local bonds and currency were regarded as expensive – belying the severity of South Africa’s fiscal problems and poor growth prospects. Against this backdrop, we trimmed our SA risk position and increased USD exposure. The market corrected in the second quarter and remained mostly range-bound in the second half of the year.
Our Fixed Income funds have performed around the top quartile in most years, which has seen the longer term performance come in around the top decile. We have achieved this with a low level of volatility and drawdown relative to peers. A client recently asked for a comment on the drivers of our long term performance and I put it down to 3 main reasons:
- The “Diversified Alpha” process – An allocation to a range of Fixed Income asset classes (money market, bonds, credit, inflation-linked bonds (ILBs) etc.), without taking excessive risk in any one asset class. We generate alpha from a broad range of sources and never put all our eggs in one basket.
- A focus on avoiding expensive asset classes – Drawdowns generally occur when an asset class corrects from overvalued levels. We focus on fundamental valuation and will aggressively reduce or sell out of asset classes like bonds, ILBs, property and/or currency. While we may miss out on a portion of the rally, this discipline has enabled us to avoid the drawdowns associated with the market correction. Examples include the “taper tantrum” which adversely affected the bond market in 2013, avoiding expensive ILBs from 2014-2017 and very low exposure to the overvalued property sector in 2013 and again in 2018.
- A high level of credit quality – Our funds focus on high quality assets with a maximum 5 year maturity. We have never bought any asset below single “A” grade credit quality. Our funds do not venture into the sub-investment grade credit space. Adhering to this conservative investment philosophy and robust credit process has enabled the fund to avoid the credit pitfalls (African Bank, PPC, First Strut, Eqstra etc.) that have affected the SA credit market.
The philosophy of “Diversified Alpha” has delivered an attractive performance signature over the long term, despite a blip in late 2017. This philosophy, combined with high credit quality and a focus on avoiding expensive asset classes, has controlled volatility and limited drawdowns. While our funds tend to forego a portion of the rally and may never experience blowout years, our Fixed Income approach is robust and sustainable over the long term.