Navigating Market Uncertainty
From a local perspective, South Africa presents the additional risk of being on the gray list, which has the potential to reduce the country’s capital inflows by an average of 7.6% of GDP, according to the IMF. In the local credit market, not all was bad news. Over the past quarter, activity has increased as more issuers return to the debt capital market, with total issuance increasing by just under R5 billion from the previous quarter.
However, despite this pick-up in activity, the market remains sluggish, evidenced by a marginal net increase in total debt outstanding of 6% year-to-date from R959.1 billion at R965.2 billion, which is most likely the result of the lackluster global macroeconomic environment. depressing business activity. This situation was further exacerbated by a persistent lack of primary market issuance within the Crown Corporation (SOC) sector.
While uncertainty reigns, one thing remains clear: we will continue to live in a volatile period in the short to medium term and we must therefore prepare ourselves appropriately to deal with it effectively.
With this in mind, it is becoming increasingly important to invest in a team or manager with the skills and experience to handle the current instability. This includes having a recognized philosophy that plays to the rhythm of a dynamic investment process at the heart of every decision one makes. It is also essential to have many levers to pull at different points in the investment cycle.
We believe that a careful and thoughtful approach to navigating the South African credit market in difficult times such as these should focus on these six key considerations, which we at Prescient Investment Management have incorporated into our philosophy and our investment approach.
1. The macro-environment
To gain a good understanding of the current state of the credit market, we keep abreast of the macroeconomic environment to identify all factors that may affect businesses and the broader market environment, such as changes in fiscal or monetary policy, economic growth or consumer spending. . For example, the currently looming gray list poses the risk of increasing transaction costs for banks operating in South Africa and restrictions imposed on cross-border transactions, creating negative ripple effects for businesses.
2. Superior credit rating
Although the exact approach differs by manager or team, we rely on a sophisticated credit scoring methodology to understand and manage the risk of a borrower not meeting their obligations. Our process, by which we quantify credit risk in quantitative and qualitative terms, also assesses risk relative to price. Our process is centered on (i) our credit cycle indicator, (ii) our internally developed credit rating process and (iii) our systematic Environmental, Social and Governance (ESG) scorecard. Using this approach, we are able to assess new and existing opportunities in the debt capital market.
3. Market complexities
A well-balanced credit portfolio invests in a range of different types of opportunities and instruments. Careful asset selection that considers probability of default, duration, instrument liquidity and credit spread duration targets is essential when selecting the best instruments in constructing optimal portfolios. For this, it is essential to have a thorough understanding of the intricacies of the local credit market, including default assessment approaches, levels of liquidity embedded in various instruments, and spreads and yields on offer.
4. Risk management, above all
Careful consideration should be given to the wide range of investment risks involved when selecting an investment. We place all quantifiable risks, including credit risk, i.e. the possibility that interest and/or principal on an interest-bearing investment will not be repaid, duration risk and, is very important, the liquidity risk, at the heart of our systematic investment process, and actively monitor them at all stages of the investment process.
5. Measured approach
The key to effective credit risk management is the ability to actively trade positions in and out in a measured manner. Our investment approach studies the credit cycle through the prism of our internal tool, the Prescient Credit Cycle Indicator (PCCI), which highlights the relationship between macroeconomic variables and the probability of issuer default. We also take into account market valuations, as measured by our implied market spread curve. By combining them, we can express a risk/return view, not only on a consolidated South African basis but also on a sector basis, allowing us to position our portfolios by theme in an appropriate and systematic way.
6. Jurisdiction in credit default
Investing in credit is not without risk – even with the best process behind one’s investment decision, borrowers default. Therefore, investors should seek a team with clear expertise in credit defaults, with the ability and skill to restructure distressed investments. Our fixed income team has over 200 years of combined market experience and, most importantly, we collectively have considerable experience in successfully managing credit events.
In these turbulent times, having a manager with a defined philosophy that you as an investor can identify with or buy into is essential. 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. Moreover, it is supported by clear strategies and processes. Through this approach, it allows us to continue to generate consistent outperformance.
Knowing that your investment manager can navigate safely through different investment themes, cycles and, most importantly, credit events through a rigorously researched and meticulously monitored approach will ultimately give you peace of mind that your savings will hard earned are well taken care of. DM/BM
Author: Conway Williams – Head of Credit at Prescient Investment Management.
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