From a local perspective, South Africa has the added risk of being grey-listed, which has the potential to reduce the country’s capital inflows by 7.6% of GDP on average, according to the IMF. In the local credit market, it hasn’t all been bad news. Over the last quarter, activity has increased as more issuers return to the debt capital market, with total issuance rising by just under R5bn compared to the previous quarter.
However, despite this uptick in activity, the market remains sluggish, highlighted by a marginal net increase in total outstanding debt of 6% year to date from R959.1bn to R965.2bn, which is most likely a result of the lacklustre overarching macro environment depressing corporate activity. This has been further exacerbated by a persistent lack of primary market issuance within the State-Owned Companies (SOCs) sector.
As uncertainty prevails, one thing remains clear: we will continue to live in volatile times for the near- to medium-term future and must, therefore, suitably prepare ourselves to navigate it effectively.
With this in mind, investing in a team or manager with the right skills and experience to handle the ongoing instability becomes increasingly important. This includes having a recognised philosophy that plays to the beat of a dynamic investment process central to every decision one makes. Having numerous levers to pull at various points in the investment cycle is equally essential.
We believe a careful, considered approach to navigating the South African credit market in trying times like these should focus on these six key considerations, which we at Prescient Investment Management have embedded into our investment philosophy and approach.
1. The Macro-Environment
To get a sound understanding of the current state of the credit market, we stay abreast of the macro environment to identify any factors that might affect businesses and the broader market environment, such as changes in fiscal or monetary policy, economic growth, or consumer spending. For example, the current looming grey listing poses the risk of increasing transactional costs for banks operating in South Africa and restrictions being imposed on cross-border transactions, creating adverse knock-on effects for businesses.
2. Superior Credit Scoring
While the exact approach differs per manager or team, we rely on a sophisticated credit scoring methodology to understand and manage the risk of a borrower not meeting their debt obligations. Our process, whereby we quantify credit risk in both quantitative and qualitative terms, also, crucially, evaluates risk with respect to price. Our process is centered around (i) our credit cycle indicator, (ii) our internally developed credit scoring process, and (iii) our systematic Environmental, Social and Governance (ESG) scorecard. Through this approach, we are able to evaluate both new and existing Debt Capital Market opportunities.
3. Market Intricacies
A well-balanced credit portfolio invests in a range of different types of opportunities and instruments. Careful asset selection that takes into account default probability, term, instrument liquidity, and credit spread duration targets is key when selecting the best instruments in constructing optimal portfolios. For this, it’s critical to have a deep understanding of local credit market intricacies, including default assessment approaches, levels of liquidity embedded in various instruments, and the spreads and returns on offer.
4. Risk Management, above all
One should carefully consider the wide array of investment risks borne when selecting an investment. We place all quantifiable risks, including credit risk, i.e., the possibility that interest and/or capital of an interest-bearing investment is not repaid, duration risk and, very importantly, liquidity risk, at the heart of our systematic investment process, and actively monitor these at all stages of the investment process.
5. Measured Approach
Key to effective credit risk management is the ability to actively trade in and out of positions in a measured manner. Our investment approach studies the credit cycle through the lens of our in-house tool, the Prescient Credit Cycle Indicator (PCCI), which highlights the relationship between macroeconomic variables and the default probability of issuers. We also consider market valuations, as measured by our market implied spread curve. By combining these, we can express a risk/return view, not only on a consolidated South African basis but on a per-sector basis as well, allowing us to position our portfolios thematically in an appropriate and systematic way.
6. Credit Default Proficiency
Credit investing is not risk-free – even with the best process underpinning one’s investment decision, borrowers do default. Therefore, investors should look for a team with clear expertise in credit defaults, with the ability and proficiency to restructure troubled investments. Our fixed interest team has more than 200 years of combined market experience, and importantly, we collectively have considerable experience in successfully navigating credit events.
In turbulent times like these, it is essential to have a manager with a defined philosophy that you, as an investor, can relate to or buy into. At Prescient Investment Management, our detailed and rigorous systematic approach is rational, rules and evidence-based, and data-driven, which leads to unbiased decision-making. Further to this, it is backed by clear strategies and processes. Through this approach, it allows us to continue to generate consistent outperformance.
Knowing that your investment manager can safely navigate different investment themes, cycles and, importantly, credit events through a rigorously researched and meticulously followed approach will ultimately give you the peace of mind that your hard-earned savings are being well taken care of. DM/BM
Author: Conway Williams – Head of Credit at Prescient Investment Management.
Disclaimer:
- Prescient Investment Management (Pty) Ltd is an authorised financial services provider (FSP 612).
- The value of investments may go up as well as down, and past performance is not necessarily a guide to future performance.
- There are risks involved in buying or selling a financial product.
- This document is for information purposes only and does not constitute or form part of any offer to issue or sell or any solicitation of any offer to subscribe for or purchase any particular investments. Opinions expressed in this document may be changed without notice at any time after publication. We therefore disclaim any liability for any loss, liability, damage (whether direct or consequential) or expense of any nature whatsoever which may be suffered as a result of or which may be attributable directly or indirectly to the use of or reliance upon the information.
- The forecasts are based on reasonable assumptions, are not guaranteed to occur and are provided for illustrative purposes only.