The Best of Both Worlds

by: Patrick Cairns

Date: Apr 23, 2018

To build an accomplished asset manager, being good at managing money is not enough. You also need to run a good business.


This is the challenge many boutique managers face, and what the affiliate model run by RMI Investment Managers seeks to address. Its success is clearly evident in Granate Asset Management’s rapid ascension to one of South Africa’s most highly regarded specialist fixed interest managers.


In mid-2015 Jonathan Myerson, Bronwyn Blood and Vaneshen Naidoo left Cadiz Asset Management to set up a dedicated fixed interest franchise within RMI. Although their record at Cadiz was excellent, the business was facing challenges.


“The team built a strong reputation at Cadiz and was very proud of what we developed, but clients became concerned about the viability of the business,” explains Myerson, the head of fixed interest at Granate. “In looking for a new business to be part of where we could continue our work without sustainability concerns, we could not have asked for a better partner than RMI Investment Managers.”


Two years on, Granate’s three offerings – the Granate SCI Money Market Fund, Granate SCI Multi Income Fund, and Granate SCI Unconstrained Fixed Interest Fund – are all top quartile performers. The firm has also grown its assets under management from the R68 million in seed money invested by RMI to almost R2.2 billion.


1STeFI; 2STeFI +1%; 3125% of STeFI; 4ASISA South Africa IB Money Market; 5ASISA South Africa MA Income


This success has been built on a very clear philosophy and process.


“We don’t forecast prices or where yields on certain bonds are going,” says Myerson. “We rely on fundamental valuations to pick up mispricing – what we call risk compensation.”


It’s classic value investing – find good assets that you can buy below their fair value.


“For instance for the better part of the last six months of 2017 our valuation model showed that South African nominal bonds were very cheap,” Myerson says. “We therefore held long positions in our funds, although not as long as we would have been without the risks associated with possible credit downgrades and fiscal issues. Following the ANC conference in December, those bonds have rallied and the risk premium has pretty much been priced out.”


At the same time, Granate’s valuation model showed, that right through 2016 and early 2017, inflation-linked bonds were much more expensive than South African nominal bonds. The firm, therefore, carried no exposure to these assets in its funds, even though they would usually be a very useful strategic part of an income portfolio.


“On average, over a long period, we would expect to hold 10% to 20% of a multi-asset income fund in inflation-linked bonds,” Myerson explains. “But because our valuation model showed that there was significantly negative risk compensation, we had none. We only started picking up some exposure towards the middle of last year when we thought that real yields would start coming down as the South African Reserve Bank cut rates. We’ve now moved closer to where we think inflation has bottomed and policy rates are low as well, and inflation-linked bonds are starting to look interesting again.”


An important enabler in managing their funds this way is that the Granate team is not at all benchmark cognisant. They don’t reference a bond index, but rather have a mandate to seek returns above the short term fixed interest rate represented by the STeFI Composite Index. In the case of the Granate SCI Multi Income Fund, the benchmark is STeFI +1%, while the Granate SCI Unconstrained Fixed Interest Fund is 125% of the STeFI.


“At no point would we be benchmark huggers,” says Myerson. “These are very active funds with the ability to change their exposure to different credit sectors.”


Although both funds sit in the South African Multi-asset Income category, they are very differently positioned.


“The key differences are their credit exposure and level of activity,” Myerson explains. “Both funds can invest across the full spectrum of fixed income, from the money market, to inflation-linked bonds, to listed property, but the unconstrained fund will typically have a higher exposure to more volatile assets. That would mean more exposure to property, longer dated bonds and inflation-linked bonds. It can also take foreign exposure, although it hasn’t yet done so, due to our conviction that the rand has been undervalued.”


This approach is unique in that it gives investors the best of both worlds in the fixed income space.


“An investor in a money market fund may be protected from capital loss in one part of the cycle, but lose out when bond funds are making capital gains during another,” says Myerson. “The unconstrained fund, however, moves its interest rate risk during the cycle, effectively acting as a money market fund when interest rates are rising and a bond fund when interest rates are declining.”


About the Author


Patrick Cairns

Financial Journalist, Moneyweb


Well-known journalist Patrick Cairns has worked in and around the financial media for over 15 years. He is one of the most respected commentators on South Africa’s unit trust and exchange-traded fund industries.