Ultra-careful approach keeps paying off for Prescient fund

[First published in Personal Finance, January 2017]


Raging Bull Award for the Best South African Interest-bearing Fund – the top-performing fund on straight performance in the South African interest-bearing short-term and variable-term sub-categories and the South African multi-asset income sub-category over three years to December 31, 2016

Certificate for the Best South African Multi-asset Income Fund on straight performance over three years to December, 31, 2016

Certificate for the Best South African Multi-asset Income Fund on a risk-adjusted basis over five years to December 31, 2016

A focus on generating returns above inflation and protecting investors’ capital from losses has earned the Prescient Income Provider Fund its second Raging Bull Award in two years.

The fund’s peers in the South African multi-asset income and interest-bearing sub-categories might out-perform it over the short term, but beating peer-group performance is not the fund’s aim. Instead, it carefully selects low-risk, interest-bearing instruments to provide investors with inflation-beating returns over the long term.

The Income Provider Fund returned an average of 9.5 percent a year over three years to December 31, 2016, according to ProfileData. The 50 funds in the South African multi-asset income sub-category with a performance history of at least three years produced an average return of 6.84 percent a year. The fund has been the top-performer in is sub-category over the five-year (9.16 percent) and 10-year (9.31 percent) periods to the end of December.

The interest-bearing short-term sub-category returned an average of 6.8 percent a year over three years, while the interest-bearing variable-term (bond fund) sub-category returned on average 6.67 percent a year.

As a multi-asset income fund, the Income Provider Fund can, in addition to cash and bonds, invest in equities (up to 10 percent of the portfolio) and listed property shares (up to 25 percent). The fund can invest 25 percent offshore and a further five percent in Africa. Funds in the interest-bearing sub-categories can invest only in interest-generating assets, such as cash and bonds. This ability to diversify gives multi-asset income funds a good chance of out-performing inflation when interest rates are low and inflation is high.

The Income Provider Fund aims to deliver a return of inflation, as measured by the Consumer Price Index (CPI), plus three percentage points a year through a full interest rate cycle, while aiming never to lose capital over a rolling three-month period.

According to the fund’s fact sheet, it invests in local and offshore money market instruments, bonds, listed property, preference shares, inflation-linked bonds and derivatives.

Meyer Coetzee, a director of Prescient Investment Management and the head of retail, says that, since the fund was launched 11 years ago, it has delivered, on average, a return of nearly four percent above inflation a year, before fees.

When selecting assets, Meyer says the departure point is to ensure that they will not result in the fund under-performing inflation over any one-year period. The managers then select instruments that will generate the fund’s return objective.

He says the fund’s exposure to high-yield, short-duration, fixed-interest instruments has been the main driver of the fund’s out-performance over the past three years. The fund has had significant exposure to cash and good-quality, short-dated floating-rate bonds.

Although the fund can invest in equities and listed property, it will not diversify into these asset classes simply to generate short-term out-performance at the risk of incurring capital losses.

(The fund currently has less than three percent in local listed property and 2.5 percent in preference shares.)

Meyer says one of the drivers of the fund’s returns over the past three years has been exposure to offshore assets.

“The challenge with offshore assets is to manage the currency risk within acceptable levels for clients with a risk profile consistent with the Income Provider Fund, because the exchange rate is notoriously volatile. The fund’s current offshore exposure is 15.5 percent, but, for a number of reasons, all the dollar exposure is hedged to rands,” he says.

“With yields on dollar assets of about three percent and a currency forward premium (the differential between local and United States interest rates) of about seven percent, the fund currently earns an average yield of 10 percent or more from this asset class. This is well on par for the overall return target of CPI plus three a year.”

The main factors that underpin the fund’s investment approach are:

  • Credit quality. The fund uses comprehensive, strict processes to check credit risk before it invests in bonds not guaranteed by the government, such as those offered by banks and listed companies. The aim of these processes is to ensure that the potential rewards outweigh the risk of credit defaults.
  • Duration. Broadly speaking, the longer the term, the higher the risk, but also the better the prospect of higher returns.
  • Hedging offshore exposure. “When the dollar strengthens relative to the rand, holding foreign assets results in higher returns,” Meyer says.

“However, the opposite is also true; hence holding offshore assets can result in significant risk for the fund. For that reason, the fund has locked in the great returns it has enjoyed over the past number of years by hedging the currency risk.”

The Prescient Income Provider Fund is managed by Cape Town-based Prescient Investment Management Company, where the interest-bearing division is led by veteran investor Guy Toms. The minimum investment amounts are a lump sum of R10 000 or R1 000 a month.

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