Delayed Impact of Rate Cut on Nedgroup Investments Cash Solution’s fund yields

The last week or so on financial markets has been almost surreal. 

Who could have predicted the events that have since unfolded and the market and societal turmoil that has followed?  Fortunately, through all this chaos though, all the Nedgroup Investments’ Cash Solutions (NICS) funds have all performed as expected, after we prepared them, prior to the Coronavirus, for any potential extreme volatility as a result of an expected Moody’s downgrade on the 27th March 2020.  As mentioned before, we reduced credit,  liquidity and interest rate risk to the lowest levels we have ever held in these funds, in anticipation of the downgrade fallout.  This conservatism has, however, been very beneficial during the unexpected Coronavirus events so far.
 
Many investors are now asking what they should expect from their fund yields after the 1% interest rate reduction by the SARB last week, in response to the crisis.  The easiest way to explain the effect on yields of the rate cut, is to compare an investment in one of the NICS funds versus a deposit in a call account.  From the charts below, the lower brown line represents a call account yield which clearly reflects the immediate cut in rates of the full 1% on Friday last week.  The green line however, represents the yield on the respective Nedgroup funds and it reflects a more gradual decline in yield over the next 3 months, assuming all things remain constant. 
 
The reason for this gradual decline in fund yields compared to a call account, is that the funds largely hold longer-dated floating rate instruments which only re-price to 3M-Jibar every 3 months i.e. the interest rate on an instrument only reduces to the lower rate when the next reset date arrives.  On average the funds hold instruments which re-price at intervals fairly evenly spread across the next 3 months and therefore, the 1% rate cut only reflects in the fund yield in small chunks over this period.  The 1% will therefore only fully reflect after 3 months and may even reflect more than a 1% decline (as in the case of the Corporate Money Market Fund) as older assets with higher spreads come to final maturity and are replaced with new lower spread assets, or as further rate cuts are introduced.  Considering that the funds are all substantially exposed to a diversified spread of the major banks in South Africa, any move out of the funds to a single SA bank at a much lower call rate would therefore only really result in an immediate decline in yield for an investor.
 
Ray Wallace, Portfolio Manager – Nedgroup Investments Cash Solutions range