How we improve the outcomes for cash investors - September 2021
To have a chance of achieving a better return than that of a short-term deposit at a bank, investors need exposure to assets with a higher expected return than cash. The Coronation Strategic Income and Global Strategic USD Income funds are managed to achieve this by:
- Taking considered interest rate and credit risk where appropriate (see more detail on these risks below); and
- Increasing exposure to alternative sources of return when the likelihood of outperformance is expected to be high.
TAKING CONSIDERED INTEREST AND CREDIT RISK
Most bonds pay a fixed rate of interest over a defined period of time. This rate is set according to prevailing market interest rates at the time of issuing the bond. Here’s what happens to the market price of the bond when market interest rates move up or down:
NOTE: The longer the period to maturity, the bigger the decline in value of the bond in the secondary market.
In simple terms, bonds can be thought of as a contract or set of promises between two parties – the bond issuer and the lender. The risk for the lender is that the borrower is unable to return the capital at the stipulated time or make the agreed-upon interest payments.
The credit risk associated with corporate bonds is higher than that of government bonds. In a worst-case scenario, government is assumed to be able to print money to make good on its obligations. Corporates therefore borrow at higher rates than governments. The difference between corporate and government interest rates is referred to as the ‘credit spread’.
We are highly cognisant of credit risk and only invest in corporate bonds when we believe that the yield compensates for the risk, or when there is a general rise in credit spreads. All credit decisions are subject to oversight by Coronation’s independently chaired Credit Committee.
INCREASING EXPOSURE TO ALTERNATIVE SOURCES OF RETURN
Investors are not always rewarded for the additional risk of diversifying into other asset classes. A positive or negative contribution from these asset classes will depend on the prevailing market environment as detailed in the table below.
Achieving a higher return than cash, however, comes with higher levels of risk. We manage risk by following a robust and consistent investment process. We apply defensive asset allocation guidelines and conduct careful research to identify individual securities trading below our estimate of fair value. Figure 2 below illustrates how often some of the asset classes detailed on page 6 have outperformed cash by 2% (the internal target of the Coronation Strategic Income Fund). Our view of changing market conditions, and how we respond in the positioning of our managed income funds, is therefore critical to successful outperformance over time.
There are, however, no guarantees that our two managed income funds will always outperform cash or protect capital over short periods of time. Our risk objectives in both funds are to protect capital in rand or US dollars over all periods of six months and longer, and to achieve significantly less volatility than that of their respective benchmark bond indices.