Seizing opportunities

The Nedgroup Investments Opportunity Fund was launched in 2011. The fund is managed with the dual objective of achieving inflation + 5% returns over rolling three year periods, with no negative 24-month periods. The fund has a maximum equity limit of 60%.

Since the launch of the fund, market conditions have been relatively favourable, and the fund has produced a return of 14.5% p.a. (relative to inflation + 5%, which has averaged 10.7% p.a. over the same period). This places the fund among the top performers in its category.

The Nedgroup Investments Opportunity Fund is structured to maximize expected returns for an acceptable level of downside risk. To this end, we are prepared to adjust the asset allocation quite actively if needs be; we will go where the opportunities are. In the past year alone, the equity allocation of the Opportunity Fund has ranged from 28% to 58% (currently* 47%), the property allocation has ranged from 2% to 10% (currently* 7%) and the funds interest rate duration has ranged from close to zero to two years (currently* 1.5 years).

In terms of asset allocation, we apply a valuation based process to derive expected returns for the various asset classes that make up our investment universe. This process quantifies how the component drivers of asset class returns will contribute to that asset class’s overall expected return. Our allocation to risk assets will increase when we are being ‘well paid’ to take on the risk of potentially larger drawdowns in the fund.

Our process tends to draw us toward assets that have an asymmetric pay-off profile. In some instances, this requires us to overlay derivative protection strategies in order to reduce the risk exposure in the fund and to negate the impact of potentially large drawdowns in some of the assets that we own. This affords us the opportunity to retain exposure to attractive growth assets but limit drawdowns in the event of an unexpected dislocation. We believe that this approach fits perfectly with the dual objective of the fund: generating inflation beating returns over the longer term coupled with a focus on capital preservation over the shorter term.

We have a number of protection strategies in place across the fund:

• a portion of our offshore currency exposure has been immunised against rand strength; 
• we have geared upside exposure to the EuroStoxx Index (top 50 listed companies across Europe) that is protected from losses over the term of the structure; and 
• bear fences across a portion of our holdings in FirstRand and Barclays Africa, which give us some upside exposure, but also some protection against the first 10% drawdown should these stocks fall.

Convertible bonds are a fundamentally attractive asset for the fund to own due to their asymmetric return profile. If the price of the underlying falls, the convertible bond behaves like a bond while if the share price increases, the convertible bond starts participating in the upside and behaves more like equity. We own some Shoprite convertible bonds. Shoprite recently released a good set of results which prompted a run in the share price, which is now at levels close to the conversion price of the convertible. Given that there is a year left before we have to decide on conversion, the pay-off profile remains attractive. We also have a small holding in the Impala Convertible Bond - which is effectively a ‘busted’ convert – i.e. unlikely to convert to equity. However, it only has 2 years until it matures and currently yields 16.5% p.a.

We recently bought Eskom dollar debt at close to a 10% yield in US dollars. We see Eskom as a strategic asset to the country and we view the default risk as low. Obtaining a 10%+ return in dollars is attractive in an environment where a large proportion of global government bond issues have negative yields. We also own Old Mutual sterlingdenominated bonds that we bought at a yield of 9%.

Our current view is that we are in a low growth, low interest rate environment globally. We expect to see continued volatility as market sentiment vacillates between fears about the risks to the global economy and fears of missing out due to the unprecedented monetary stimulus that we have witnessed. Locally, we believe the downside risks to South Africa’s economic outlook have increased - it seems inevitable that consensus growth expectations will be downgraded (again), inflation will be revised higher and interest rates will be increased. Political risk remains elevated. We are mindful of these risks and therefore retain a strong preference for quality companies that will be able to grow their profits and dividends in these challenging times.

A high conviction holding in the domestic equity portion of the fund is Steinhoff, an integrated household goods business with global operations. Despite very strong share price performance over the last few years we remain excited about their prospects for the following reasons:

• Steinhoff is playing a consolidating role in a very fragmented European household goods market. 
• Steinhoff recently purchased PEP. PEP is an early mover in the eastern European value clothing market. They have achieved fantastic brand reception and the rollout plan of PEPKOR is accelerating under the Steinhoff leadership. 
• Steinhoff owns their property portfolio. They are valuing their property portfolio at a yield of 7.3%. European REITS are valued at anywhere between a 2.5% – 3.5% yield. We would expect this value to be unlocked over time. 
• Steinhoff’s recent listing on the DAX will increase their international investor awareness and should provide buying support from tracker funds. 
• We expect earnings to grow by more than 50% over the next three years, and continue to see scope for aboveaverage levels of growth well into the future.

We will need to remain vigilant to deliver on our performance objective, given the current high levels of volatility and generally low levels of risk premia available in the market. The Nedgroup Investments Opportunity Fund is currently relatively conservatively positioned and yields in the region of 6%, which is high relative to history. This should provide a stable underpin to the fund and a solid platform from which to build should more opportunities present themselves.