Search for yield in unprecedented times. July 2020 Search for yield - - PowerPoint PPT Presentation

Investec Specialist Investments (“ISI”)

July 2020

Search for yield in unprecedented times.

The conservative portion of the efficient frontier is becoming a crowded space with 40% of total CIS assets (cR800bn) currently invested in interest bearing instruments – but it remains a compelling investment allocation as a component of an investors’ portfolio

2

Search for yield in low interest rate environment

15% 49% 2% 34%

ASISA CIS Industry allocation

Equity Multi Asset Real Estate Interest Bearing A portfolio above this curve is impossible Return %

Risk Free Return Low Risk / Low Return Medium Risk / Medium Return High Risk / High Return

Optimal portfolios should lie on this curve (knows as the Efficient Frontier) Risk % (Standard Deviation) Portfolio’s below the curve are not efficient, because for the same risk one could achieve a greater return

Source: ASISA, Investec

Sources of income and yield – multiple applications

3

Source: ASISA, Investec

Contribution Phase Withdrawal Phase Company Pension Funds Retirement Annuity Living Annuity Guaranteed Annuity Regulation 28

Lifecycle accumulation and income needs of an individual

4

Income needs become critical in the last few years as we approach retirement and in the years post-retirement

Secures a pre-determined income Flexibility to choose the desired income and investment strategy (subject to regulatory limits) Capital preservation and predictable income are critical

Sources of income and yield for individuals and corporates

5

“When people talk about cash being king, it's not king if it just sits there and never does anything” Warren Buffett

But we need to ensure its appropriate and can enhance your return

Cash Money Market Fixed Deposit Income Funds Dividend Income Retail Bonds Bonds

With many investment strategies utilising an inflation linked benchmark, investors are able to earn excess returns from their fixed income allocations with significant less volatility than the inclusion of equities. Income assets have recently been more volatile than historically but provide a substantial real return and on risk adjusted relative basis, continue to offer a compelling proposition despite the unprecedented fall in interest rates.

6

Income producing assets continue to outperform

But in a discretionary world income decisions are impacted by the net income after tax is considered

7 100 110 120 130 140 150 160 170 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Jun-18 Sep-18 Dec-18 Mar-19 Jun-19 Sep-19 Dec-19 Mar-20 Jun-20

Cumulative returns – effect of tax

STeFI MM net (individual) MM net (Corporate) ALBI CPI

Money market investments have been able to produce a real return over time (approx. 1%-2%) but this is often eroded when tax is taken into consideration, specifically for investors at the top marginal income tax brackets

Source: Iress, Investec

2.00% 3.00% 4.00% 5.00% 6.00% 7.00% 8.00% 01-01-15 01-04-15 01-07-15 01-10-15 01-01-16 01-04-16 01-07-16 01-10-16 01-01-17 01-04-17 01-07-17 01-10-17 01-01-18 01-04-18 01-07-18 01-10-18 01-01-19 01-04-19 01-07-19 01-10-19 01-01-20 01-04-20

Historic real return

3m Jibar MM net return 63% of Prime Net return post DWT CPI

What is the attractiveness of income

8

Conservative Risk Profile Capital Preservation Liquidity Consistency Predictability Regular Income Low Volatility

Cash is the starting point for all portfolio construction. The relative riskiness for all investment decisions starts with the decision relative to risk free assets but all follow similar characteristics

What about dividends as a source of income?

9

95 115 135 155 175 195 215 01-Jan-12 01-Apr-12 01-Jul-12 01-Oct-12 01-Jan-13 01-Apr-13 01-Jul-13 01-Oct-13 01-Jan-14 01-Apr-14 01-Jul-14 01-Oct-14 01-Jan-15 01-Apr-15 01-Jul-15 01-Oct-15 01-Jan-16 01-Apr-16 01-Jul-16 01-Oct-16 01-Jan-17 01-Apr-17 01-Jul-17 01-Oct-17 01-Jan-18 01-Apr-18 01-Jul-18 01-Oct-18 01-Jan-19 01-Apr-19 01-Jul-19 01-Oct-19 01-Jan-20 01-Apr-20 01-Jul-20

ALSI vs ALSI Total Return

ALSI ALSI TR

Dividend income is an important component of the portfolio return but exposure to equities comes with volatility. Investors want the ability to earn a consistent and steady income return so you need to protect the capital and limit the volatility to isolate the dividend income.

Source: Iress, Investec

Dividend income funds fit the profile for investors

10

What are the primary income needs of a Corporate?

• Protect the balance sheet
• Remain conservative
• Ensure access to liquidity

Corporates therefore favour conservative investment offerings with most of the allocation to money market funds

Excess Return

What are the primary income needs of an Individual?

• Access to liquidity for transactional requirements
• Preserve capital
• Opportunity cost for other investments

The conservative approach is not always appropriate for individuals depending on their lifecycle stage with cash balances specifically high in volatile environments

Conservative Risk Profile Consistency Predictability Regular Income Low Volatility Capital Preservation Liquidity

Preference shares provide an alternative source of dividend income

11

Senior secured (covered bonds) Preference shares Subordinated (Tier I) Senior secured (asset backed) Subordinated (lower Tier II) Subordinated (upper Tier II) Equity Senior unsecured Depositors

EQUITY

• Reflects ownership
• Undated term
• Dividends are

discretionary

DEBT

• Reflects obligation
• Set repayment dates
• Debt provider is entitled

to interest at a predetermined dates throughout the term

HYBRID INSTRUMENT

Paid last Paid first

PREFERENCE SHARES

ISI BCI Enhanced Income Fund

(EIF)

Investment philosophy

13

ISI BCI Enhanced Income Fund (EIF)

“There is no single overriding investment philosophy that works under all market conditions at all times. Stock selection and asset allocation decisions are difficult to consistently predict.”

We believe in utilising a systematic approach to focus on our core investment capabilities to provide clients with access to the full universe of instruments available in order to deliver on the desired client outcomes with the highest level

• f probability.

Investment Strategy Regular Review Client Goals Risk Profile Asset Allocation

Investment Process

Investment process

14

ISI BCI Enhanced Income Fund (EIF)

15

Objective:

‒ To produce regular income largely in the form of dividends

Aims to provide:

‒ Outperformance of money-market portfolios after fees and tax ‒ Diversified exposure to high quality assets issued by major banking groups, financial institutions and select large corporates ‒ A liquid investment ‒ Consistent and predictable income ‒ Low capital volatility

Investment philosophy of providing a portfolio of dividend yielding assets that is diversified:

‒ Instrument type: instruments that are subject to different aspects of taxation ‒ Issuer type: spread across a variety of banks, financial institutions and corporates ‒ Flexible approach to take advantage of changing market dynamic and maintain consistent income with minimal capital variability ISI BCI Enhanced Income Fund (EIF)

Competitive advantage:

‒ Investec preference share team to issue or source competitively priced local redeemable preference shares ‒ Investec equity derivative and structuring capabilities to provide equity hedging capabilities ‒ Investec offshore balance sheets, Credit Investment teams enabling inward listed preference shares

Investment objective

Sources of income - focus on what you can control and be flexible to adapt to changing market dynamics

16

Asset Allocation Alternative Strategies Structuring Dividend Credit Liquidity Regulatory

• Predictability
• Low volatility
• Consistency
• Regular income

Utilise the full investment universe to achieve the desired client outcome with the highest level of probability. Access to scarce and specialist investment opportunities. Leverage the collective expertise to leverage trading, structuring and origination of assets with specialist support expertise in tax and legal.

Yield

Interest rates determine the absolute target level of returns. Does not take any interest rate views and hedge duration (assets are variable). Utilise the term structure to provide yield enhancement.

• Predictability
• Liquidity
• Flexibility
• Excess return

Evaluate assets that efficiently and sustainably meet our criteria for liquidity, risk, return, diversification and Investability. Credit worthiness of an asset provides the ability earn risk adjusted returns.

• Conservative
• Liquidity
• Flexibility
• Excess return

Investment Universe Risk Management

Duration Yield Curve

CLIENT OUTCOME AND INVESTMENT OBJECTIVE

Define the target return, investment objective and investable universe ISI BCI Enhanced Income Fund (EIF)

17

ISI BCI Enhanced Income Fund (EIF)

Credit risk Dividend risk Interest rate risk Liquidity risk

v

Risk mitigation in current environment

Regulatory Portfolio construction Diversification Accessibility

18

Multi Asset approach

Money-market allocation for short-term liquidity purposes Preference shares: Core allocation of the Fund to redeemable / cumulative preference shares (listed and unlisted) issued by local banks and financial institutions Equity hedge instruments provides flexibility and liquidity

• Purchases dividend yielding equities and fully hedge

equity market risk Inward listed preference shares enhance the diversification:

• ZAR denominated inward listed redeemable preference

shares on the JSE

• May be credit linked to obligations of acceptable global

rated entities (e.g. Goldman Sachs, Barclays, RBS, Lloyds, HSBC)

• Fully hedge interest rate and currency risk

6% 35% 40% 19% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Money-market Local pref. shares Equity hedge IL pref. shares

Asset allocation – 30 June 2020

Money-market / Cash 5-15% Redeemable preference shares 15%-60% Equity hedged instruments 15%-60% Inward listed preference shares 10%-25% Current asset allocation reflects limited issuance of preference shares by local banks and taking advantage of the flexibility of Equity hedge trades ISI BCI Enhanced Income Fund (EIF)

Portfolio Construction

The EIF has provided capital stability and a consistent return with continued expected outperformance despite the low level of interest rates

19

85 87 89 91 93 95 97 99 101

16/06/2020 08/06/2020 31/05/2020 23/05/2020 15/05/2020 07/05/2020 29/04/2020 21/04/2020 13/04/2020 05/04/2020 28/03/2020 20/03/2020 12/03/2020 04/03/2020 25/02/2020 17/02/2020 09/02/2020 01/02/2020 24/01/2020 16/01/2020 08/01/2020 31/12/2019 23/12/2019 15/12/2019 07/12/2019 29/11/2019 21/11/2019 13/11/2019 05/11/2019 28/10/2019 20/10/2019 12/10/2019 04/10/2019

Capital history

2.6 3.0 3.4 3.7

1 2 3 4 5 6 MM - Individual EIF - Individual MM - Corporate EIF - Corporate Annual %

Forward looking yield 30 June 2020

Tax

• Div. WT

Pre-tax eq.

4.7* 5.4* 4.7* 5.1*

Assumptions:

• Individual tax rate of 45%
• Corporate tax rate of 28%
• MM forward yield of 4.7%

0.00 00 0.20 20 0.40 40 0.60 60 0.80 80 Oct-19 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 %

After-tax outperformance over MM

Individual Corporate

ISI BCI Enhanced Income Fund (EIF)

0.51 0.52 0.57 0.52 0.55 0.43 0.4 0.42

0.1 0.2 0.3 0.4 0.5 0.6 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 % after fees but before tax

Distribution History

EIF Fund1

Disclaimer

20

Out of the Ordinary