Insights, Updates and News

Flexible Income Fund

By Anil Jugmohan, Senior Investment analyst

The Nedgroup Investments Flexible Income Fund is a low risk income fund that aims to outperform cash rates with low levels of risk. The fund aims to achieve this objective through providing dynamic exposure to a multitude of income generating asset classes that include: cash, vanilla and inflation-linked bonds, credit bonds, convertible bonds, preference shares, listed property and offshore income generating assets. The fund is suitable for investors with investment horizons of 6 months or longer.

The fund has managed to achieve its performance objectives, having produced returns of 9.2% p.a. over the past seven years, which is 1.7% p.a. in excess of the average money market fund. The table below highlights that the fund has also delivered pleasing results when compared to the universe of funds with similar objectives.

Importantly for investors with shorter time horizons, the fund has managed to deliver on its objective with a high degree of consistency. The chart below shows that the fund has outperformed a cash investment 84% of the time when measured over a rolling 12-month period. Periods of underperformance have been infrequent and of low absolute magnitude.

The chart below shows the fund’s risk-return characteristics along with the asset classes that make up the investment universe. We’ve also highlighted the maximum drawdown of each asset class in brackets over the period of analysis (Aug 08 - Feb 14).

A number of interesting observations can be gained from this analysis:

- As already alluded to, the Flexible Income Fund has outperformed SA Cash by a healthy margin, without taking on much additional risk (as measured by volatility on the horizontal axis). The largest drawdown on the Flexible Income Fund was -1%.

- SA bonds, Inflation linkers (ILB’s) and Preference Shares have all produced similar returns to each other (and the Flexible Income Fund) but with significantly higher levels of volatility (6-8%) and drawdowns (-8%).

- While Property has given the best returns over the period, it has done so with high levels of volatility (14%) and a large drawdown of -32%.

- Rand weakness has been a source of returns over the period but these have not come smoothly, with the rand having the highest volatility (18%) and maximum drawdown (-36%) of all the asset classes surveyed here.

The Sharpe Ratio measures so called ‘risk-adjusted’ returns or the excess return above cash achieved by an investment relative to its levels of volatility. The chart below demonstrates that the fund has scored well on this measure, especially when compared to the individual asset classes that make up the investment universe and the peergroup.

How has this result been achieved? The fund manager, Abax Investments, uses a valuation-based investment approach that attempts to identify assets with attractive income streams with low levels of capital risk. The manager is vigilant in evaluating market prices within the context of the global investment landscape to identify significant asset mispricing and potential risks to asset prices. Careful portfolio construction ensures appropriate diversification. The chart below shows how the flexibility of the mandate has been utilised to produce these consistent returns for clients.

As can be seen in the asset allocation chart below, the asset allocation has shifted over time based on valuations and the outlook for the various asset classes. As an example, in late 2008 the weighting of Money Market instruments was at a peak, consistent with the cyclical high point in the available market yields of those instruments. At the same time, the rand was very weak making offshore investments relatively unattractive.

Currently, the bulk of the portfolio is held within floating rate corporate bonds which offer an attractive yield pick-up over cash without significant interest rate risk. The fund has also maintained an exposure of approximately 10% to Preference Shares and 8% to short term inflation linked bonds which have a high level of inflation carry. Although the offshore exposure is currently 12%, two thirds of this exposure is currently hedged back into rand, limiting the potential negative impact of rand appreciation.

More recently, small allocations to Listed Property and Convertible Bonds have been added, post weakness in these asset classes. Exposure will continue to be increased opportunistically.

Overall, the fund’s duration remains low at 0.5 years in order to protect against interest rate risk. Abax have noted that they are cautious to extend the duration and prefer to remain focused on capital preservation.

In summary, the Nedgroup Investments Flexible Income Fund has met investors’ expectations consistently over a long period of time. The fund has provided an enhancement over cash while not overly exposing investors to high levels of risk. The focus will remain on capital protection while maximising yield by adopting a disciplined approach to security selection and asset allocation.

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