Fitch Affirms Southchester (RF) Limited at 'AA+(zaf)'/'V2(zaf)'
KEY RATING DRIVERS
The affirmation of the National Fund Credit Quality Rating (NFCQR) is driven by the fund's high and stable credit quality, as reflected in the fund's weighted average rating factor (WARF) of 0.22 at end-February 2015 and rating distribution, while factoring in the fund's concentration risk.
The affirmation of the National Fund Volatility Rating (NFVR) is driven by the fund's low exposure to interest rate risk and spread risk, as reflected in the fund's short maturity profile, while recognising the fund's potential exposure to longer-dated securities through repurchase agreements.
Asset Credit Quality
The fund's weighted average credit quality is high, reflecting investment policies that require the portfolio to invest 90% of its assets in securities rated 'A(zaf)' or above. While the fund can have a limited exposure to lower-rated securities, this exposure is infrequent and limited in practical terms.
The fund invests in buy-and-sell back repo transactions with unrated repo counterparties. When considering the fund's credit exposure, in view of the collateralised nature of the transaction, Fitch treats this counterparty exposure as direct exposure to the underlying collateral. The fund only invests in collateral which meets its investment guidelines for credit quality and maturity of assets.
Concentration
In Fitch's opinion, the fund is concentrated, with a top three issuer exposure consistently in excess of 50% of portfolio holdings. In line with its applicable rating criteria, Fitch reflects such higher concentration risk in its assessment and overall NFCQR.
The fund's concentrated holdings reflects its investment mandate and the structural characteristics of the South African market, with a limited supply of treasury bills, and the five largest banks having a combined market share of around 90%, according to Fitch's estimates.
Portfolio Sensitivity to Market Risks
The fund has low exposure to interest rate risk, as dictated by the fund's investment policies, which limit to 90 days its weighted average maturity (WAM) to interest rate reset date. Exposure to spread risk is also low, as a result of the fund's investment policies, which limit the maximum maturity of individual assets to three years and place limits on the portfolio's weighted average life (WAL, i.e. maturity to final maturity date) to 150 days - when the maturity dates of buy-and-sell back repos are included in the calculation - or 450 days when these contracts are excluded.
The fund's market risk factor is consistent with a 'V1(zaf)' NFVR. However, the fund may invest in instruments not accessible to money market funds in South Africa and its maturity profile is longer overall. Therefore the agency believes that a 'V2(zaf)' National Fund Volatility Rating best reflects the fund's overall market risk profile.
Fund Profile
Structurally, the fund is a debenture-issuing fixed income portfolio, regulated under the Commercial Paper Exemption Notice 2172 as issued by the Registrar of Banks in 1994 in terms of the Banks Act of 1990. It falls outside the Collective Investment Schemes Control Act of 2002. The debentures have an initial maturity of six years and can be redeemed by debenture holders daily, with a maximum T+2 settlement. The debentures rank pari passu among themselves and a negative pledge exists over the issuer preventing it from engaging in any other activities while any debentures remain outstanding. Economically, Fitch considers Southchester directly comparable with a mutual fund.
The Advisor
Fitch considers the manager suitably qualified, competent and capable of managing the fund.
The fund is managed by Southchester Investment Managers (Proprietary) Limited, a small independent fixed income asset manager established in 2014. Southchester is authorised by South Africa's Financial Services Board. Southchester delegates record-keeping, valuation and reporting services to Peregrine under a service level agreement (SLA), and delegates independent compliance-monitoring services, independent fiduciary services and credit research to respected third-party providers.
The fund managers are Andra Greyling and Gregg Bayly, who have 27 years and 20 years of investment management experience, respectively. Additional oversight is provided by Societe Generale Securities Services (Proprietary) Limited (a division of Societe Generale; A/Negative/F1) as custodian and trustee. Fitch considers as positive for the rating Southchester's recent hires of experienced staff to strengthen governance and the operational framework: Rentia Munro as COO/investor relations and David Morris as Non-executive Director to oversee corporate governance.
RATING SENSITIVITY
The ratings may be sensitive to material changes in the credit quality or market risk profile of the fund. A material adverse deviation from Fitch's guidelines for any key rating driver could cause ratings to be downgraded. Specifically, Fitch would expect to downgrade the NFCQR in the event of deteriorating credit quality and/or changes to the fund's investment guidelines to allow a larger portion of lower rated assets.
Given the fairly short maturity profile of the fund and the conservatism already considered in the NFVR, the rating is expected to be stable. However, should interest rates or market volatility in South Africa structurally change, or the maturity profile of the fund be materially extended, then Fitch would expect to downgrade the NFVR.
Without structural evolution of the South African market which results in a more diverse, high quality and liquid issuance market, it is highly unlikely that Fitch could rate the fund higher than 'AA+(zaf)'.
For additional information about Fitch rating criteria applicable to bond funds, see the criteria referenced below.
Southchester provides Fitch with monthly portfolio information, including details of the portfolio's holdings and credit quality.
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