As a multi-manager, Sygnia allocates assets to many different asset managers under a variety of investment mandates. One of these, albeit a very small one given Sygnia’s R130 billion in assets under management, is a corporate bond mandate.
As a multi-manager, Sygnia allocates assets to many different asset managers under a variety of investment mandates. One of these, albeit a very small one given Sygnia’s R130 billion in assets under management, is a corporate bond mandate.
Corporate bonds, as opposed to government bonds, include all debt instruments issued by corporates, parastatals and other institutions. They account for between 23% and 28% of all listed debt on the JSE.
The rationale for investing in corporate bonds is that the higher risk associated with such instruments is reflected in the higher yields achievable. Corporate bonds are thus widely used for ‘yield enhancement’ within all bond, income and money market funds.
This became increasingly apparent when the collapse of African Bank (Abil) in August 2014 had the largest impact on money market funds.
Over the past year we have become increasingly concerned about the liquidity in the corporate credit market, and recently decided to terminate a R150 million mandate in order to reduce our corporate bond exposure. The response from the appointed asset manager to our termination letter included the following sentence:
“I reckon you are looking at approximately a 1.5% ‘haircut’, but quite frankly I don’t know how long it would take to sell. Offering approximately R150m of credit into the market all at once might shock it.”
The corporate bond market in South Africa is frozen once again. You can easily buy corporate bonds, but you cannot subsequently sell them. We did not think that R150 million was a particularly large mandate (it is about 0.1% of our asset base). It turned out that in the current corporate bond market context it is impossible to terminate an investment without suffering losses relative to what we had been led to believe the ‘valuation’ was.
This reminds me of a similar event just after the global financial crisis when a new client of Sygnia’s had been invested in what they perceived to be a safe flexible income unit trust. When Sygnia tried to restructure their investment strategy and withdraw the assets (approximately R600 million) from the unit trust involved, the actual value ended up being more than 5% lower than what the asset manager had quoted when previously reporting performance. And it took nine months to disinvest the assets.
Many conservative investors, including pensioners, invest in what they perceive as “safe” money market, flexible income and bond funds. The implied promise of investor safety underpins all the marketing of such products. The fragility of this promise was exposed by the events around Abil last year, but unfortunately memories are short.
The fact that the corporate bond market is frozen and illiquid has many implications. It means that the performance figures provided to investors are simply broad estimates, as your assets cannot easily be sold at the price implied by the published returns. The actual valuations are, at best, based on quantitative valuation models, and at worst on the prices quoted at the time the instruments were last traded, which may have been months previously.
Secondly, any management fees and performance fees paid are then based on those fictitious valuations. And finally, if you are a sizeable investor, it will take months to realise your investment when you need to get your money back. If you are a small investor you might not be affected. However, should a large number of small investors decide to exit at the same time, the illiquidity will affect you as well.
What constitutes a sizeable investor? It appears that R150 million, which is a relatively small amount when it comes to fixed interest investments, does the trick. If ten bond managers in South Africa decided to sell just R15 million each that would “shock” the corporate bond market, according to at least one asset manager.
Now that the Abil dust has settled, the lessons learnt should be taken to heart. Investors should be more conscious of what their unit trusts are holding (income, bond and money market funds in particular). If you are invested in a fund that has significant exposure to credit instruments, and that is a material part of your overall wealth, then there is a case for diversifying that exposure.
Investors should also carefully consider whether the risks involved in squeezing a higher yield from their investments are worth it. They should avoid being seduced by higher published returns, as the actual performance may be significantly lower.
Asset managers, on the other hand, need to explain corporate credit and all the associated risks to their investors. The true meaning of illiquidity is a good start.