Multi-asset income funds are seen as low-risk unit trusts, but that doesn’t mean that they are risk-free. How the fund manager deals with those risks should be one of the most important considerations for any investor.
“We are very focused on risk management,” says Anton Eser, chief investment officer at 10X Investments and manager of the 10X Income Fund. “We know that capital preservation is a top priority for income fund investors, and we never want to incur a loss of capital.”
The fund is therefore conservatively managed, but still delivers a high level of income. It has dual objectives of providing a return of 2.5% ahead of inflation and 1% above the money market over any three years.
Since its inception in November 2022, it has achieved both of those goals.
“We have twin objectives, because we want to make sure that we give investors real returns, and we want to outperform what they could earn from cash,” Eser says.
The fund invests across a portfolio of fixed-income securities, including government bonds, money market instruments and corporate bonds. It can also invest up to 30% offshore.
In line with its risk-conscious approach, the fund does not invest in equities or listed property, even though those are allowed in funds in this category.
“We are very focused on long-term asset allocation,” Eser says. “We are not stock pickers, and we are not tactical asset allocators trying to time the market.”
In positioning the fund, 10X Investments considers the valuations of all the available asset classes in the income space. To get a long-term view, it uses the cyclically adjusted price-to-earnings ratio (CAPE ratio), which smooths out earnings over the past 10 years.
“We then look out five years and estimate, based on current valuations and some degree of mean reversion, what the likely returns from different asset classes will be,” Eser said. “That gives us an idea of where we should be allocating, but we only make the final decision after thinking very hard about the potential risks.”
For example, the 10X Investments income fund currently holds almost no corporate credit; either locally or internationally. There is an opportunity to pick up high yields; however, This is because even though there is an opportunity to pick up some high yields, Eser believes that the risks are too high.
The number of companies defaulting on their debt has been picking up in the US and Europe, and South Africa also experienced the default of credit instruments linked to the taxi industry.
“Given where we are in the credit cycle and how low the risk premium is to hold credit, we don’t think this is the right time to own credit in an income portfolio,” Eser says.
“The average income fund in the local market has around 30% to 40% invested in credit. We think that doesn’t make any sense, given that you can build a relatively high-quality portfolio without it that is still generating a yield of 10%.”
The yield to maturity on the 10X Income Fund is currently 9.8%. And over the past year, the fund has delivered a total return of 11.3%.
“In the investment industry, often you think you have to be busy by investing in different asset classes or bringing in different instruments. But at some times in a cycle, keeping it simple is the best thing,” Eser says. “And in the income space right now, keeping it simple is the best thing.”
The fund is currently generating attractive real yields, mainly from nominal and inflation-linked bonds in South Africa.
Eser particularly likes the opportunity in inflation-linkers. These make up 30% of the portfolio and are offering yields of inflation + 5% to inflation + 6%.
“For a portfolio looking to generate CPI + 2.5%, this is a fantastic opportunity,” Eser says.
The portfolio also holds close to 30% in South African nominal bonds.
“Since this fund looks at a three-year outcome, we limit duration in the portfolio at 3,” Eser said. “And for pretty much the last six months we have been close to that.”
The bulk of the remainder of the portfolio is in short-dated money market-type instruments – around 20% in South Africa and 15% offshore.
“When we invest internationally, by default we hedge out the currency risk,” Eser says. “We don’t think investors should be exposed to the volatility of the rand in an income portfolio. We want to lock in the yields we are getting in international markets without the risk of the rand moving against us.”
With interest rates likely to start coming down both in the US and South Africa in the coming months, the fund has locked in some attractive yields that will deliver returns for investors for some time. However, as the environment changes, the fund will also adapt.
“As real yields come down, the trade-off between holding inflation-linkers and holding credit changes,” Eser says. “When we see those dynamics and we are no longer generating inflation + 5% from a very simple approach, then we will need to think about other ways I can introduce yield into the portfolio.”
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