Asset Manager Review
Craig Sherman, credit fund manager at ASHBURTON INVESTMENTS
says the company does its own ratings for each counterparty, with the exception of the sovereign, and only use the external ratings for benchmarking purposes.
“The recent rating agency ratings downgrades are significant in the lives of investors as the cost of capital is now higher and growth rates can be expected to be lower.
“Changes in ratings may also force investors to sell South African bonds as a result of no longer qualifying for inclusion in certain indices.
“This could have significant pricing implications for affected assets. These effects have so far been manageable but will be more significant if further downgrades occur.
“Although our investment views have not changed, the downgrades mean that our rating framework will now set the SA sovereign at BBB(local currency) and so we will adjust the ratings of some of our counterparties.
“Our portfolio valuations will be adjusted to the extent we change any of our counterparty ratings. “More of our corporate counterparties will now also be at or pierce the sovereign ceiling which will create some interesting pricing opportunities.”
Craig Sorour, head of SA research at LAURIUM CAPITAL
says notwithstanding the failure of rating agencies to highlight problems in the sub-prime market during the global financial crisis, they remain a very important reference for evaluating credit risk.
“A downgrade to a country’s credit rating typically results in increased borrowing costs – consumers feel the pinch, corporates generate lower profits and rising cost of capital negatively impacts valuations.
“In turn, these factors discourage investment both from local and foreign investors and the economic buffer often manifests in the form of a depreciating currency.
“To an extent the problem becomes somewhat self-fulfilling as a large percentage of USD denominated products such as oil and food commodities are imported, which pushes inflation up further.
“The S&P and Moody’s downgrade to junk status related to our foreign currency rating – the local currency rating remains investment grade.
“A key and fairly high probability risk is that the latter will also be downgraded to junk which will preclude many foreign investors from holding local bonds.
“Although we don’t expect this to happen in 2017, we anticipate that this further downgrade will result bond outflows in excess R120-billion.
“Consequently, substantial currency outflows will occur placing further pressure on the Rand.
“Ahead of the recent downgrade we had a bias for Rand hedge stocks and we retain our cautious stance towards domestically focused stocks,” says Sorour. in of
Samantha Steyn, portfolio manager at CANNON ASSET MANAGERS says the ratings agencies definitely
have an effect on the economy as growth is affected by a downgrade.
South Africa depends on foreign investments and, unfortunately, foreigners shy away from sub investment grade economies.
Similarly, local companies delay infrastructure and investment spend in these uncertain times, which stalls economic growth.
This all has a negative impact on job creation, consumer spending, business sentiment and therefore earnings of our local, South African facing companies.
“That being said, there is no correlation between credit ratings and the equity market pricing.
“This is due to the underlying companies within most equity markets being diversified outside of the local economy, as we have here in South Africa.
“The most noticeable impact, by far, is on those local companies that earn revenue predominantly in South Africa. The impact on such companies, particularly cyclical companies, has been evident.
“We have seen a selloff in the banks, retailers and the mid- and small-companies that will be affected by lacklustre growth.
“The downgrade did have a negative effect on our portfolios, as investors sold off stocks such as Sasfin and The Foschini Group.
‘This is expected post a downgrade as the cyclical, interest and growth sensitive stocks come under the most pressure.
“Earnings and growth expectations for most of these companies have been revised downwards, following the downgrade. Steyn says the downgrade has, however, not changed the company’s investment views.
“We continue to manage portfolios that are diversified, hold attractively priced counters and consist of businesses with solid balance sheets that are able to withstand tough environments.
“We are value managers and therefore do not pay up for growth.
“Companies that were previously priced for excessive growth have been sold down to the greatest extent, which hasn’t affected us given that we do not invest in these counters.”
Henk Viljoen, STANLIB’s
co-head fixed interest business says the credit rating agency ratings play a role in investment decisions for a portfolio when the mandate requires ratings from specific ratings agencies.
“Where the portfolio mandate does not require an external rating agency, we apply the internal credit rating calculated.
“An assessment is done on the issuer, evaluating qualitative and quantitative factors as well as peer comparisons to determine the internal credit rating.”
Peter Kent, co-head fixed income, and Bashier Omar, portfolio manager at INVESTEC ASSET MANAGEMENT
say ratings can play an explicit role in the company’s portfolios when they are written into the mandate.
As they are an independent assessment of credit quality they are often used as a rule of what is an appropriate level of credit risk in the portfolio.
For example, they are often used to distinguish between investment grade and non-investment grade, or to estimate the overall portfolio by using a weighted average rating of all the names in the portfolio.
“So, whilst ratings can be an explicit portfolio consideration, our credit investment decisions Questions for fund managers:
are driven more by our assessment of the underlying issuer fundamentals and strongly influenced by the broader macro and technical trends we observe (for example, economic outlook, market liquidity, sub-asset class outlook).
“We subscribe to all of the recognized rating agencies - we use their independent opinions as one of a number of sources of information to inform our credit views and therefore investment decisions; however we do not rely on any rating agency opinion.
“We employ in-house credit analysts and economists who specialize by sector across geographies and are able to tap into our in-house equity research capability where needed.
“They play a crucial role in both the initial investment decision and the continuous monitoring of the credit portfolio post investment.
“Our analyses and conclusions may be influenced by information and views gleaned from amongst other sources, brokers dealers, internal and external economists and through engagement with National Treasury or company management,” says Kent.
Ockert Doyer, credit analyst at SANLAM INVESTMENTS
says credit ratings are useful and although credit rating agencies have been criticized for getting certain ratings very wrong (sub-prime mortgage backed securities in the US, for example) their approach (methodologies) and processes (analysts presenting to credit committees) in assessing credit risk have been refined over many years.
“While we use external ratings agencies as additional information, actual investment decisions are driven by the results of our own credit assessments.
“The most value derived from external ratings lies in understanding the methodology followed to derive the rating.
“The rating rationale, that is, the explanation of the thinking behind the actual credit rating, is most useful in our view.”
Tyron Green, credit analyst at PSG ASSET MANAGEMENT
says the company acknowledges the external rating agencies’ ratings and comments but has its own ratings matrix.
“Like our equity process we consider the 3Ms in our rating matrix. The 3Ms being moat (a company’s market share and ability to maintain pricing power), management (management integrity, how they have optimised the balance sheet returns and managed the risk) and margin of safety (in pricing, free cash flow generation and distance to default of covenants).
“We also undertake a full legal review of the Domestic Medium Term Note Programme and Applicable Pricing supplements and understand the cash flow waterfall and security structure (if any).
“Our collective assessment of the counterparty drives our ultimate rating which feeds into our fair-value model.”