Discovery Diversified Income Fund

By fund managers, Peter Kent and Malcolm Charles

The fund aims to outperform South African bond indices as measured by the benchmark over rolling two-year periods. The fund may include offshore investments as legislation permits.

From a return perspective, the fund is tethered to the bond market. This means that when the bond market does well, investors in this fund are able to reap the benefits. The flipside is that when the bond market has a tough time and underperforms cash like it did in 2015, investors are protected because the fund is positioned to return an income threshold.

This fund could typically be used to provide investors with a high level of income while seeking opportunities to maximise capital gains. Over the last six months, the fund managers have held a very bond-positive view, which has driven outperformance during this period. The fund has, in fact, outperformed the benchmark – the Stefi Composite – over all periods since inception as below:

Source: Morningstar to end March 2018

Interest rates set to rise locally and globally

Positive developments during the quarter, namely; the cabinet reshuffle, February Budget Speech and the Eskom board overhaul, renewed investor sentiment and signalled political will to set South Africa on a path of correction. However, while these developments have proved great for local markets in the immediate aftermath, the follow-through on key institutional reforms including but not limited to state-owned enterprises, the mining charter and land appropriation will be crucial if this momentum is to be sustained throughout 2018, as also highlighted by Moody’s.

The local macroeconomic environment has been supportive of local fixed income markets to date, as seen by the performance of local bonds and the currency over the period. The inflation trajectory remains supportive, although our forecasts indicate it may have bottomed out and should start to tick up while remaining well within the South African Reserve Bank’s (SARB target band). We believe that political risks have largely dissipated since the turn of the year and macro fundamentals are increasingly supportive of rate cuts. The robust debate currently ensuing within the Monetary Policy Committee (MPC) is one of anchoring expectations lower versus stimulating weak growth, and in our view, there is a reasonable chance of another quarter-point cut in the near term.

The outlook for global growth still remains positive and monetary accommodation looks set to continue at a gradual pace, although the recent spike in volatility and uncertainty could upset moderate economic growth. The Fed is now a long way down the tightening road. Longer term, we feel that we are closer to the end of the Federal Open Market Committee’s tightening cycle than the beginning of it, and believe that the neutral interest rate is nearer 2.5% than 3%. With higher growth, inflation should rise and this will likely improve the Fed’s confidence in raising rates further. European growth has slightly cooled although the underlying economy remains broadly stable. However, the lingering hung parliament in Italy continues to be an elevated risk for political stability in the region. While the outlook on China has been positive, we believe an accelerated slowdown in Chinese growth will pose a risk to emerging markets.

Investment grade credit is a key portfolio component

We believe local bonds still offer value relative to fundamentals and their emerging market peers and should comfortably outperform cash in the near term. While we remain constructive on local bonds, we remain cautious as the market has already priced in a dose of good news. This could lead to yields drifting slightly in the short term and as such we have trimmed some of our duration. Our allocation to nominal bonds remains firmly positioned on the short and belly parts of the yield curve.

We took profits (sold after a good run) in inflation-linked bonds towards the end of the quarter, taking off some duration and reducing our overweight to the asset class. In our view, inflation has reached its nadir and should begin to tick up, though, we expect it to remain anchored within the SARB’s 3-6% target band, ending the year off circa 4.7%.

The local listed property scene has endured a turbulent first quarter owing to significant headwinds from the resilient stable. Stock-selection has thus been a key factor in delivering performance and our preference for domestically-focused property counters has yielded value for our portfolio. We have taken a bit of risk off our property positioning in line with our cautious stance across the fixed income spectrum as we head into the second quarter and maintain our preference for counters offering both quality and liquidity in this sector.

Investment grade credit remains a vital part of our portfolio. While we have reduced our overweight position in the asset class, we will look to add short-dated, good quality paper at the margin as we search for yield as and when opportunities arise.  Our investments remain focused on defensive sectors with strong bottom-up fundamentals and they are mostly invested in bank, insurance and real estate names.

Our exposure to foreign currency in the portfolio serves as a buffer against local rate-sensitive risks and deterioration in the local unit, which we believe is trading at slightly expensive levels relative to bonds. We maintain a diversified basket of currencies with a lion’s share apportioned to the greenback and the remainder allocated to the Japanese yen and the euro.

Disclaimer

^{This article is meant only as information and should not be taken as financial advice. For tailored financial advice, please contact your financial adviser. Discovery Life Investment Services Pty (Ltd): Registration number 2007/005969/07, branded as Discovery Invest, is an authorised financial services provider.}

^{What to know before investing in collective investment schemes (unit trusts)}

^{Before you invest in a collective investment scheme, there is important information you should know. This includes how we calculate the value of your investment, what affects the value of your investment, and investment charges you may have to pay. This notice sets out the information in detail. Speak to your financial adviser if you have any questions about this information or about your investment.}

^{What the investment is}

^{This Fund is a Collective Investment Scheme (also known as a unit trust fund) regulated by the Collective Investment Schemes Control Act, 45 of 2002 (CISCA). Collective investment schemes in securities are generally medium- to long-term investments (around three to five years).}

^{Who manages the investment}

^{Discovery Life Collective Investments (Pty) Ltd, branded as Discovery Invest, is the manager of the Fund. Discovery Invest is a member of the Association of Savings and Investment South Africa (ASISA).}

^{You decide about the suitability of this investment for your needs}

^{By investing in this Fund, you confirm that:}

• ^{We did not provide you with any financial and investment advice about this investment}
• ^{You have taken particular care to consider whether this investment is suitable for your own needs, personal investment objectives and financial situation.}

^{You understand that your investment may go up or down}

1. ^{The value of units (known as participatory interests) may go down as well as up.}
2. ^{Past performance is not necessarily an indication of future performance.}
3.  ^{Exchange rates may fluctuate, causing the value of investments with international exposure to go up or down.}
4. ^{The capital value and investment returns of your portfolio may go up or down. We do not provide any guarantees about the capital or the returns of a portfolio.}

^{How we calculate the unit prices and value the portfolios}

1. ^{We calculate unit trust prices on a net-asset value basis. (The net asset value is defined as the total market value of all assets in the unit portfolio, including any income accrued and less any allowable deductions from the portfolio, divided by the number of units in issue.)}
2. ^{The securities in collective investment schemes are traded at ruling prices using forward pricing. (Forward pricing means pricing all buy and sell orders of units according to the next net-asset value).}
3. ^{We value all portfolios every business day at 16:00, except on the last business day of the month when we value the portfolios at 17:00.}
4. ^{For the money market portfolio, the price of each unit is aimed at a constant value. This means that all returns are provided in the form of a distribution and that a change in the capital value will be an exception and only due to abnormal losses.}
5. ^{Buy and sell orders will receive the same price for that day if we receive them before 11:00 for the money market portfolio and before 14:00for the other portfolios.}
6. ^{We publish fund prices every business day, with a three-day lag, on www.discovery.co.za}

^{About managing the portfolio}

1. ^{The portfolio manager may borrow up to 10% of the portfolio’s market value from any appropriate financial institution in order to bridge insufficient liquidity.}
2. ^{The portfolio manager can borrow and lend scrip.}
3. ^{The portfolio may be closed in order to be managed according to the mandate (if applicable).}

^{Fees and charges for this investment}

^{There are fees and other charges for this investment.}

^{The fees and charges that apply to this investment are included in the net asset value of the units and you do not have to pay any extra amounts. These fees and charges may include:}

• ^{The initial fund management fee}
• ^Commission
• ^{Incentives (if applicable)}
• ^{Brokerage fees}
• ^{Market securities tax}
• ^{Auditor fees}
• ^{Bank charges}
• ^{Trustee fees}
• ^{Custodian fees}

^{You can ask us for a schedule of fees, charges and maximum commissions.}

^{The total expense ratio}

1. ^{Total expense ratio means a measure of a portfolio's assets that have been expended as payment for services rendered in the management of the portfolio or collective investment scheme, expressed as a percentage of the average daily value of the portfolio or collective investment scheme calculated over a period of a financial year by the manager of the portfolio or collective investment scheme.}
2. ^{A percentage of the net asset value of the portfolio is for fees and other charges relating to managing the portfolio. The percentage is referred to as the total expense ratio (TER).}
3. ^{A higher TER does not necessarily imply poor return, nor does a low TER imply good return.}
4. ^{The current TER is not an indication of any future TERs. If fees go up, the TER is also expected to increase.}
5. ^{During any phase-in period, the TERs do not include information gathered over a full year.}

^{Transaction cost}

1. ^{Investors and advisers can use transaction cost (TC) as a measure to work out the costs they will incur in buying and selling the underlying assets of a portfolio.}
2. ^{The transaction cost is expressed as a percentage of the daily net asset value of the portfolio calculated over three years on an annualised basis. (This means the amount of interest an investment earns each year on average over three years, expressed as a percentage.)}
3. ^{Transaction cost is a necessary costs in administering the Fund. It affects the Fund’s returns. It should not be considered in isolation as returns may also be affected by many other factors over time, including:}
   • ^{Market returns}
   • ^{The type of fund}
   • ^{The investment decisions of the investment manager}
   • ^{The TER.}
4. ^{Where a fund is less than one year old, the TER and transaction cost cannot be calculated accurately. This is because:}
   • ^{The life span of the fund is short}
   • ^{Calculations are based on actual data where possible and best estimates where actual data is not available.}
5. ^{The TER and the TC shown on the fund sheet are the latest available figures.}

^{The views expressed in this article are those of the author and may not necessarily represent those of Discovery Invest.}

^{Discovery Life Investment Services Pty (Ltd): Registration number 2007/005969/07, branded as Discovery Invest, is an authorised financial services provider.}