Income funds to ‘sweat’
Although South Africa’s rate cycle has turned and there may be further rate hikes to come, companies continue to recognise the need to enhance the yield on their operational, core and strategic cash reserves. Globally, money market funds have been used by corporations since the early Seventies to provide for yield pickup, diversification and access to rates further along the yield curve. Furthermore, by using money market funds companies do not have to sacrifice liquidity and hence pay penalties on f ixed deposits in those situations where cash is required before the expected or planned date of expenditure.
Notwithstanding the recent rate hike in SA, global and domestic rates are hovering around all-time lows. This has forced companies to look for alternatives for their core or strategic cash and as a result, investment by corporates into fixed income unit trusts has become common practice in SA. While there are various providers offering suitable solutions, it is imperative that treasurers, financial directors and chief financial officers who are considering investments into fixed income funds clearly understand what they are investing in and what the associated risks are. SOME KEY POINTS TO LOOK OUT FOR AND UNDERSTAND INCLUDE: Fixed income funds can have broad mandates. Today, for example, you may compare a few fixed income funds which on the surface look similar as they all have exposure to corporate credit, an asset class widely acknowledged to be in the ‘sweet spot’. The underlying mandates of the funds may however be very different, with some able to invest more broadly into asset classes like listed property. Corporate investment mandates may not allow for this asset class. Be sure to understand clearly what the fund can and cannot invest in. Pay attention to the recommended investment horizon of the fund. A twoyear horizon for core or strategic cash for example, may not be appropriate, as longer duration funds mean a larger risk to interest rate moves than shorter duration funds and potential capital losses. A fund that holds mainly f loating rate notes, such as the Investec High Income Fund, will have lower duration. The value of f loating rate notes f luctuates much less in response to market interest rate movements than the value of fixed rate bonds. Make sure the credit risk is understood. Does the fund have a rating? Is it limited to only investing in investment grade counterparties or can it invest lower? Credit risk refers to the risk that a borrower will default on its debt. The risk rests primarily with the lender, which in this case would be the corporate investor, given the ‘ look through principle’ of investments into unit trusts. Fixed income fund mandates, that have been designed with the corporate investor in mind, should have a conservative approach to the credit in which it invests. The strength of the asset manager’s credit process and team should be explained. Fixed income f unds do not have a constant net asset value ( NAV) like money market funds, which means that accounting for the returns will differ to that of money market f unds. Your provider should explain this before the investment is made so that the accounting for such f unds is understood. You also need to ensure that your treasury systems can accommodate this. Be sure to understand the different measures of performance and yield. Ask your provider what the difference is between the forward yield, current yield and past performance, as these measures can result in completely different outcomes and are sometimes quite misleading. Does t he f und distribute i ncome monthly or quarterly? Most corporate investors prefer a monthly distribution, as accounting for the interest monthly is far easier than quarterly given that most accounting systems are set up for monthly interest. Most fixed income funds allow access to the investment within 48 hours, but this does not necessarily mean that these funds are suited to operational or transactional cash investments. The depth and experience of the investment team managing your cash reserves is also a key consideration. Many companies in SA have reaped the benefits over the last year of identifying what portion of their cash is operational, core and strategic, and placing these into funds ranging from money market, ‘near’ money market to f i xed income funds. Investec Asset Management’s core corporate fund range returned between 5.70% to 7.60% gross of fees over the year to December. The blended return has meant that corporates are better positioned to ‘sweat their cash’ in times of lower interest rates, but it is imperative that these companies who hold excess cash ask the right questions, understand the risks and match the returns accordingly.
By Charlene Muller, Head: SA Corporate Sales, I nveste c Asse t