Tune in as Warren Ingram, Sajjaad Ahmed and Conway Williams from Prescient Investment Management, reveal the intricacies of debt markets and the pivotal role of analysts. Discover the synergy between fixed interest investments and equities, strategies for portfolio diversification, and tips for optimizing returns.
Have a question for Warren? Don't forget to voice note your questions through our WhatsApp chat on (+27)79 807 8162 and you could be featured in one of our episodes. Follow us on Twitter, LinkedIn and subscribe to our YouTube channel for more Financial Freedom content: @HonestMoneyPod
Tune in as Warren Ingram, Sajjaad Ahmed and Conway Williams from Prescient Investment Management, reveal the intricacies of debt markets and the pivotal role of analysts. Discover the synergy between fixed interest investments and equities, strategies for portfolio diversification, and tips for optimizing returns.
Have a question for Warren? Don't forget to voice note your questions through our WhatsApp chat on (+27)79 807 8162 and you could be featured in one of our episodes. Follow us on Twitter, LinkedIn and subscribe to our YouTube channel for more Financial Freedom content: @HonestMoneyPod
Brought to you by Pressient Investment Management. Informed by science, guided by insight. Pressient Investment Management is an authorized FSP.
Speaker 2:Welcome to another episode of Honest Money. We're talking about the part of the investment market that's other than, probably, residential real estate. The biggest part of investment markets. One attracts, I think, the least amount of attention from people like me when we're on podcasts or on radio and stuff, because maybe, to be honest, we don't understand it well enough and we're not intelligent enough to explain it. So I thought, well, I can own it now. I'm not bright enough to explain it, but I can bring in some heavyweight backup. And I've decided to bring in and that wasn't a weight Joe Conway, but I've brought in some heavyweight backup here. Conway Williams has been with us before. He's head of credit at Pressient Investment Management, and then he's brought in Sir John Ahmed from Pressient as well and he's what they call a quant analyst, sir John, we're going to start with. What on earth is a quant analyst?
Speaker 3:I pretty much make Conway's life a lot easier by crunching the numbers for him. But at Pressient it's a systematic data driven house and with that you need someone or a team of people rather to then take all of the data that comes in from your various sources and then do some analysis and some research and hopefully turn that into like a tradable investment signal. So my job essentially is take all of that in, see how that applies to credit space or, more broadly, the fixed income space, and then see if we can then use that to make money for our clients. At the end of the day, Okay.
Speaker 2:So for those of us out there that aren't the best at maths, that's what you're telling us. You know how to make numbers sing and find a story and kind of an investment opportunity, either to buy or to avoid in the numbers. Well, we try.
Speaker 3:We try to try.
Speaker 4:So I think we just take one step back. We're operating in the investment world and in that investment world you need to be able to have those signals to either buy, sell or hold. Generally, in a traditional house, what you would see is you'll have analysts who are sitting there at Excel behind an Excel spreadsheet, crunching numbers and the likes. That is the way that I was raised in terms of my formal training and the likes. Now we've got guys like Sir Jai to come with a much more statistical and mathematical background. Also, I have ability to code.
Speaker 4:So if you're just thinking in terms of prescience DNA, we are largely a quantitative house, more of a systematic investment house now, and what that means is we don't want somebody to be sitting behind an Excel for two, three weeks crunching numbers. We want to build systems and tools that are repetitively or able to be used repeatedly, be more efficient in terms of how we crunch the numbers so that again we can go through more investment opportunities quicker, because again we've got this quantitative models and research methodologies and also the systems and the tools that allow us to effectively go through probably about 120 million data points per day that we analyze. And imagine doing that through Excel. It'll take me years. So that is why we've got a team of young quant. I think we've got about 15 quant across the floor, across all of our strategies, who sit there and make, as Sir Jai said not the portfolio managers lives easier, but make all of our lives easier because ultimately, we all need to be investing somehow or the other.
Speaker 2:So I'm trying to wrap my head around that. 120 million data points every single day yes, that's unbelievable, so okay. So thank you for the explanation. I feel intimidated, which is good. That means we've got the right brain power on this recording. So now we're talking about the world and the jargon. I just want to get it out the way. We'll often hear about fixed interest and fixed interest instruments or fixed interest funds, etc. And maybe just a bit of background there. So when we're talking about that, what are we really covering?
Speaker 4:So I think, just to go back to the various types of asset classes, the debt asset class or, as you would have just mentioned now the fixed interest asset class, is a class of actual, that that's within the market that we fixed interest instruments are actually issued, and what that simply means is it's government debt, it's corporate sort of debt, it's all different types of debt instruments that investors invest in and in ultimately providing the underlying borrower, whether it's government or the corporations, with these type of instruments. So what we do is we provide loans to in buy. We are the investor. We provide loans to these various issues for over, for a period where they are either quarterly or monthly or six monthly payments, and then you get your money back right at the end. Obviously, it's not always risk-free. There is an element of risk or an element of volatility included, depending on what you're looking at. But again, these instruments provide you with that periodic, stable type returns, because that's those income of the cash flows that come in each and every period or contractual period that you've now negotiated.
Speaker 2:So for someone investing, the important thing here to understand is that, according to me, the side of the investment markets is multiple times bigger than the stock markets. If you look at these bigger fixed interest or debt markets, whether it's South Africa or around the world, it's many times bigger, and it's amazing how much more attention in the media maybe not in the actual investment management space, but certainly in the media how much more attention gets given to a share price moving up or down. We also have stated on Tesla selling more cars or less cars, and then everyone talks about that ad nauseam, but they're not looking at if there is a Tesla bond and they've issued debt to the market. Are they able to pay? And that's what we're talking about. We're talking about that side of the equation today.
Speaker 4:Yeah, and I think the reason that I suppose we operate in a bit more of the boring part of the world we don't earn upside.
Speaker 4:So if Tesla the share price moves by three, four, five times, we don't benefit from that, and that is probably why outside of the market is not seen as a sexy part of the market.
Speaker 4:We will buy a Tesla bond or, in the South African instance, whichever sort of issuer comes to the debt capital markets. We will agree a price of bid at an auction and earn a specific return and that's the only return that you get. So we are looking at downside protection as opposed to the ability to earn multiples of something that you've invested and, to be honest, that's not the sexiest part of the market because you're not going to be earning three, four, five times money. But again, that's the ability, is what's a key advantage of our market. You know what you're going to be earning, over which period and when you're going to be getting your money back. And that's why I said we need to have these coins and the credit analysts that again looking at it from the risk perspective, because we need to make sure that we protect downside risk as opposed to considering that upside in terms of what you could earn.
Speaker 2:So maybe to bring Sahaja Danya, we've got to give him a chance. When we look at something like that, you're not I mean, it's a silly example, because I don't think he sits foot in South Africa anymore but you wouldn't, for example, sit down with Elon Musk and say, tell me your story and tell me the prospects for your company. You're looking at other information. When you're looking at a bond that a company would issue, what are you looking at?
Speaker 3:Yeah, so from our side, what's key to us is being able to pay those interest coupons monthly, quarterly, semi-annually, as well as being able to pay us back the amount of the loan right to the end of the period or, in some cases, to reduce it, as we can have contractual payments along the life.
Speaker 3:So you know that big lump sum at the end. But we're looking at things like cash flows, interest cover ratios. Are you making more than enough money to pay back your interest on an annual basis? Are those cash flows in positive? Or, in the case of, like Tesla, they're typically burning a lot of cash in that initial growth stage. So it might be a bit more risky. As you look at a stable company, something like a retailer, they've got customer shopping every single day, they've got cash coming in and they have sufficient cash on hand to then pay back those loans. So that's something we'd be a bit more comfortable with. They'd get a bit of a bit of pricing on the interest rate side, as opposed to something a bit more aco-cyclical, to put it that way.
Speaker 2:So we're not really that excited, or let's not say excited, we're not that interested actually in the company's growth prospects, whether they're going to double or treble their revenue for the next five years. What we're interested in is the revenue that they're earning today, the cash that they're taking out of that revenue. Can they afford to fund the debt and pay that debt back to us now during every six months, and then at the end of the term they can give us the capital back up we lent them? Yeah, so I get it why you say it's not sexy. But I do think, in an environment like we're in, where there is so much uncertainty and so much instability within kind of the geopolitics and economics, that getting an investment that can move differently to the stock market and I think that's an important point, but secondly that's potentially less risky than the stock market To me starts to sound quite attractive, especially when interest rates are higher than they've been for quite some time.
Speaker 3:Yeah, definitely. I mean, we've seen international evidence as well that you don't even have to give up equities completely and shift into the fixed interest space. You can create a blend of your portfolio and then using those correlations sometimes negative, sometimes just lower you can then construct a portfolio that's a lot smoother in terms of its return profile without having to give up too much on the app side, just by blending those two together.
Speaker 2:So let's just talk about that. There's some key phrases there return, profile. So we're taking I mean very simplistically, we're going to take a bond from one company, maybe by shares in a totally different sector in another company, and what we're saying is, when we put those together, that one plus one might get us to two and a quarter, because we might lose a bit less if the share goes down. We're still going to get some return from the bond. If the share booms, we won't get the growth from the bond portion, but the two together gives us a bit of a smoother investment ride, a bit more predictable, a bit more stable. So we get a bit of stability, but we're not walking away from all capital growth because we've put two assets together. Yes, yeah, how do we do that? I mean, if we're looking at that in the investment world, how do you kind of figure out where you'll get one investment that will go up while something's going down, or at least kind of protect your capital? How do you make those decisions?
Speaker 3:So what's typically done is you will get an estimate of the volatility of your underlying investment, which is essentially how much the returns move, either on a daily or monthly, annual basis.
Speaker 3:You can do that for various equities, you can do that for various bonds, maybe even REITs or listed property, for example. Then you can also look at the aesthetic returns or even forward-looking returns that you'd earn on those asset classes and once you plot those on a chart where you have your volatility on one axis and your returns on the other, you can then sort of get what we call an efficient frontier, which is also pretty well known in the finance theory side of things. Then, using that frontier, you can get assets that will move not necessarily in the same direction all the time, but then offset each other based on the risk return profile. Then, using an optimizer which is something we do at present quite often, we can select that optimal mix of portfolios or mix of instruments quite well to build out your portfolio. So you can target either a certain level of return or you can target a certain level of volatility and then construct the other side to match that in the investors' favor.
Speaker 4:If you want me to bring it down to one level, literally all you're trying to do is if you'd like a return of X%, what must your portfolio look like? Or based on your risk tolerance. If you are a young 20 to 30-year-old, you obviously have a very different risk tolerance to somebody who's 50 to 55. But it's considering imminent retirement. So you look at what your needs are and then we'll try to build portfolios that give you that risk profile and also what the potential return profile is, and then we'll have that blend of actual fixed interest instruments, equity instruments, offshore currency and the like. So you put that all in the pot. But the important part is that generally, fixed interest instruments exhibit a negative correlation to your traditional asset classes, like your equities. So when equities are booming, it might do something different. Or when there's a sell-off in equities, fixed interest exhibits a profile that's very different. And combining those two gives you a smoother journey towards retirement, and that's the important part.
Speaker 2:So when we're talking about negative correlation, in other words, if the stock market's going up, you might find actually that your fixed interest, your bond portion of your portfolio, your overall, is actually going the other way. It might actually be making money Not always, but that's what we're talking about. If one's going left, the other one's potentially going right. When we're talking about negative correlation, and when you put those together, then you're hoping that in down times, the thing that is losing money will be kind of offset by the other part of your portfolio where it's going up. And there's no guarantee that any of us are sitting here today to say we know that in the next 12 months it's going to be shares that are going down and bonds going up, all the other way around, we don't know. But the idea then is put the two together and then, when life happens, whatever it is, some part of your portfolio might be losing money but some part will be making money and over time you get a more kind of predictable investment outcome.
Speaker 4:Exactly that and I think Sajjad just touched on it is that our research, and even international research by one of the most prominent investing groups out there, vanguard, shows that the inclusion of fixed interest instruments helps you with diversity and it actually reduces the volatility of your earnings. I think that is very, very important. Diversity, like we said, is one of the only free lunches out there, and if you build your portfolios accordingly, you can have a smoother journey towards retirement, and that is ultimately what we want to give up, lance.
Speaker 2:So let's just talk a little bit about credit now, because to me it's not really spoken about much. And we're in the world of maybe we understand we've heard the R186 or R whatever it's going to be in the future government bonds, but we don't talk a lot about company credits and to me it could be something that we may be getting a bit of a potentially better return. But then you're taking on company risk and now I'm saying to myself are we now going to gambling, or is this kind of safe as houses? Where are we in this?
Speaker 3:Definitely Cool. So I mean from you just mentioned the R186, for example. So that's a government bond that's maturing in 2026, for example. So you've got about three years to maturity and it's fixed rate. What you can then do is, if you go to the corporate side of things, they typically use that government curve as a benchmark. So then for that additional credit risk that you're taking on by lending to a company specifically, they will give you an extra, let's say a percent, for example, on top of that R186 bond.
Speaker 3:So for the exact same term to maturity, to investment horizon, you'll get that pickup for your credit risk. But embedded in that also is your liquidity risk premium. So your government bonds obviously trade much more frequently, especially in South Africa, where the credit market is still building up that liquidity as the market grows. So with that additional return, if you are a bit old investor, which we typically are, you can then lock in that return for that three, four year horizon, outperforming your government bonds, potentially even less or similar levels of volatility, assuming that credit spread doesn't move. I mean the credit spread you're referring to is that pickup you get for taking on that risk. And then, if you combine that with your government bond portfolio. You can then get in answer returns above the government bond index, for example, and then, taking that one step further, combining those with equities, and you get that smaller return profile, as we mentioned.
Speaker 4:So you want me to give you a real-life example, warren. So the credit space is where we, as investors, provide corporations, state owned entities or anyone that is a borrower with a loan. That is what we're doing, and then, as you mentioned earlier, we look at the health or the actual sustainability of cash flows and the likes to see if they can pay us back. That is what credit is and that is what we do on the daily.
Speaker 2:So in a situation like that I mean that's where the analysis gets key right You're not simply just lending money to anybody that asks. You're going in to say, over and above taking the risk of giving money to the government, now we're taking company risk, so we're going to do proper homework and be very sure that extra 1% or so return that beginning we're being paid to take a little bit of work, but maybe the risk is not as much as people think out there.
Speaker 4:Yeah exactly.
Speaker 2:So what happens? I mean nobody, not even the springbox are perfect. So what happens when things go wrong with a company and you've got their credit instrument, you own their debts? Who gets money first, you or the shareholder, Someone who's bought their share?
Speaker 4:So I think you have to understand. In normal theory, there is a capital structure. So, depending on what type of instrument you buy, it depends, if there's a default, who gets money first or who gets money last. So we tend to purchase senior, unsecured bonds in the debt capital markets and that what means. What that means is that we generally rank right on top, but we don't have security. So that is what we do. So most of the bonds issued in debt capital markets are senior, unsecured. That ranks ahead of equity, ranks ahead of mezzanine or subordinated type instruments if there is a default. So I think the only where there's a little bit of a difference is if you're playing in the bilateral market or the unlisted market. You generally get security as well, and that is the only time that somebody would rank ahead.
Speaker 4:So if there is a default, you actually want to know that your manager has actually dealt with defaults or restructures before and tried to get the company on a solid footing again. Sometimes it requires equity to be injected. In the worst case, you need fondle holders to take a little bit of a hit. But all of that is how you want to actually firstly get the company on a better footing and rework the capital structure so that you can potentially the company can continue as a going concern. If you can't see a future of a company, then it could go into either insolvency proceedings, business rescue, or debtors or assess. Funders would take that security salad and try to get our money back. But it's again. It's quite the intricate process and that is why we make sure that we not only look at the health of the company but we have a legal resource that actually looks at the contracts between the borrower and lender to make sure that all of our rights are protected.
Speaker 2:So I think it's an important point. When you buy a share in a business and you buy it on the stock exchange and it goes south and if it really goes bad, your share might be worth nothing, and that's just tough luck. That's life. But when you earn a debt, the debt of the company and, as you say, if it's senior and structured, that means you've got quite a lot of recourse to at least recouping, if not all of the money, some of the money, and maybe not all at once, but over time. And that's often why for people out there, when you wonder, why is it that I've got nothing back for my shares and things went wrong, but the debt, the holders suddenly own the company. That's what we're talking about. This is exactly the reason is because you've got, if you're the debt holder, that senior and secure debts is the deal. You are first in line. Everyone else stands behind you.
Speaker 4:Yeah, that is correct, but it takes a lot of work for us to actually get that company on better footing or ultimately to pull the plug and put that company into business rescue. So, again it's, we operate in a very intricate place and then, very importantly, we try, while we're trying, to minimize that downside. We're only earning the coup point. And that is why we're buying those instruments with those type of characteristics, like senior secured or senior unsecured, because you know that if something goes wrong, at least you can solve that and recoup your capital at the end of the day.
Speaker 2:I'm sorry to interrupt you, Conway Conway. We're running out of time and I'm desperate to ask two more questions. One, just the state of this credit market. It's not something I get to talk a lot about, so while I've got you, I want to kind of get all the information I can. What's the state of the SA market now, this credit market?
Speaker 3:Oh, I'll take that one. So I appreciate being a systematic house. We've systematized our view on the credit market. So we are starting point is our credit cycle indicator. So we take various macroeconomic variables, so things like consumer sentiment, business sentiment, cpi or inflation, the exchange rate, and then we try and match those up to default probabilities. So we've also got our own in-house default probability assessment. So when we issue a loan to a company, we need to know what is probably they're gonna default over the next year, next two years, next three years. So we try and match up those variables so that, without having to wait for financial statements to be released like every year, we can then look at what are the economic variables looking at right now, what are those telling us, and we can then form a view on the credit market. So keep taking that.
Speaker 3:And then also the returns you earn within the credit space. We're looking at your spreads over either government bonds or even over three month trial buff, for example, floating rate instruments. We compare the two and we can see are you getting sufficient return for the amount of risk that we're seeing in the credit market at the moment? And the picture over the past year has pretty much been one of deteriorating credit conditions, things such as LadyRD coming into the fray, load shading the very tough economic environment with spreads continuing to tighten Once we overlay those two together.
Speaker 3:We've sort of been borderline between neutral and somewhat negative on the credit space at the moment, but that doesn't mean that there aren't opportunities out there. For example, if you look at our IELTS credit fund the recent income plus fund we are pretty much top quarter within the multi-acid income space with over 100 funds. So we are able to use our systematic expertise to look at how things are at the moment. You can then use that to find certain opportunities we believe can add value. And it doesn't mean that because we're in a neutral to negative view on the credit market that we can't generate returns, because we very much can do so with expertise of our own credit team.
Speaker 2:Okay. So we're in a situation where things are not all well and I think it doesn't take a rocket scientist to figure that out in the credit market. But understanding that the whole market is not in the best space doesn't mean that one can't take advantage of some nice opportunities when you find them. Okay. So thank you. And now Sejalad. We've got our favorite question for new guests to the show. Conway has already had the privilege of this. So if you were to meet your 18-year-old self with the benefit of the experience that you've got now, what would be the one life lesson that you would like to teach yourself?
Speaker 3:I think it's pretty much. Don't be afraid to take chances when they come up. If you see an opportunity to either learn something or to do something, jump on the seats with both hands and then make as much of it as you can, and that will set you up better for the day of your life.
Speaker 2:Fantastic. I think that's a lovely way to close. Thank you so much. I think we're close to our record for the longest podcast ever.
Speaker 3:It's been really good.
Speaker 2:I appreciate it. I think our listeners have learned as of high, and thank you so much.
Speaker 3:Thanks guys, Thanks to you.