Fairtree BCI Income Plus Fund Q4 2025 commentary

Market dynamics

Global risk

The global bull market, which started at the beginning of the second quarter, continued without much resistance into the fourth quarter of 2025, with equities across the board rallying strongly over the period. The large-cap Dow Jones Industrial Average delivered 4.03% to investors. But the rally in the US was dominated by large caps as the broader-based S&P 500 Index underperformed somewhat, producing a decent 2.65%. The NASDAQ followed the broader market, producing 2.72% in total return during the period. Looking at these numbers in terms of the historic dataset, the Dow Jones produced its 36th best quarter since Q2 2007, or some 75 quarters of data. So essentially, the index produced an “average type” quarter, not far better than the series median return of 3.95%. Table 1 shows the total returns of the major Western equity indices over the fourth quarter, as well as the rankings of the fourth quarter, to contextualise the returns. Looking purely at rankings, we can observe that the FTSE 100 was the pick of the bunch, delivering 6.86% and the 14th best ranked return of its history since Q2 2007.

Moving to the quarterly performance of European credit, the iTraxx suite of indices produced yet another set of positive numbers. The iTraxx Crossover 5-year Total Return Index produced another good quarter, posting 2.16%, which outperformed European cash quite comfortably. Our more favoured 2x levered index, a more realistic measure of the risk-adjusted relative performance of European credit, produced a healthy 3.82% for the quarter. We have consistently stated that in the absence of meaningful defaults, the iTraxx Crossover suite remains a good compromise of risk and available returns, and we feel that the index on a levered basis should offer a better risk-adjusted opportunity to investors who are willing to accept an excess premium to insure company credit.

On the default side of the coin, Markit reported one meaningful default over the quarter, which is Ardagh Packaging Finance PLC, which has been a component of iTraxx XOver Series 16 to Series 43. Series 16 was launched on 20 September 2011, and Series 43 was launched in March 2025. It subsequently fell out of the on-the-run Series 44 in September 2025 but has been an integral part of the European sub-investment-grade credit benchmark for some 15 years. At this juncture, the date has not been set for the recovery auction, but the market price indicates a recovery of around 40%, which is in line with average recoveries of sub-investment-grade credits.

Table 1: Major Index Q4 2025 total return and historical rankings Q2 2007 – Q4 2025

Source: Bloomberg, 31 December 2025

Given the fact that we have 18.75 years of quarterly data, we can do more than just look at the outright performance numbers as well as the relative rankings. We can also have a look at relative risk measures, such as standard deviations, Sharpe Ratios, and other measures of risk-adjusted returns. Obviously, this should be important to investors who do “feel” risk in the diffusion of the performance that they have been delivered. For the same absolute return in a portfolio, only a fool would be happy with more risk for that return than less risk. There are many definitions of what risk is, and what is important, from a risk perspective, for one investor might be quite different from another, but we feel that the most consistent and comparable is the time-tested standard deviation, which has its roots in its underlying mathematical construct. This makes it consistent in its treatment of any distribution of potential outcomes. It does not rely on the distribution being “Normal” or Gaussian, but the formula can be applied to any set of data and is consistent in its approach. How one uses the standard deviation in conjunction with the mean return over the historic dataset is what might give us some insight into what “bang” we get for our “risk buck”.

We have always contended that excess returns to risk-free might only be a compensation for the risk (or uncertainty) of outcomes, and is grounded in a Capital Asset Pricing Model (CAPM) framework. We would suggest that the simple calculation of mean divided by standard deviation gives a good measure of risk-adjusted return and is one that we tend to like to look at. This is not the Sharpe Ratio (SR), as the SR strips out risk-free return as well as the volatility of that risk-free return, but we feel that the basic return per unit risk ratio is a good proxy for the slightly more rigorous SR. Obviously, a higher number is better as the investor receives more return for the risk accumulated. We must be aware, however, that a high number on its own cannot be viewed as the “Holy Grail” since any low volatility index might deliver high levels of Return Coefficient but might not deliver that much by way of return. For example, it might be foolish to buy an index that produces 0.4% annual return with 0.2% annualised volatility – a return coefficient of 2, rather than an index that produces 12% return with a standard deviation of 8%.

Table 2 shows the annualised returns, the annualised risk, as well as the return coefficients for the major indices that we monitor. The so-called return coefficient is simply the annualised return since Q2 2007 divided by the realised annualised standard deviation of quarterly returns over that same time period. It differs from the Sharpe Ratio in that the Return Coefficient does not take into account prevailing short rates in the relevant currency, and therefore, is not a measure of “excess return” but rather total return.

Table 2: Index Risk-Adjusted Return Coefficient

Source: Bloomberg, 31 December 2025

As an extension of the last quarter’s report, Figure 1 below shows the cumulative return of the various indices in the currency of the particular index domicile. The various performance traces have been indexed to 100 at the beginning of the second quarter of 2007, when we have the complete historical data for the iTraxx XOver and Main total returns.

When looking at Figure 1, it also becomes apparent that there are no meaningful returns to risk-free. The worst-performing traces over the 18.75 years are the iTraxx Main Index (125 equally weighted global investment grade credit names) and the US Treasuries total return index. Looking at the delivered risk, it becomes apparent that US Treasuries are not the least risky asset class but rather the well-diversified investment grade CDS Index – iTraxx Main. They have generated the lowest returns coupled with the lowest associated risk over the past 18.75 years. This makes sense as the US Treasury index volatility is driven by the fluctuations in bond yields. The index has a modified duration of approximately 5.58%, while the iTraxx Main 5-year Total Return Index has a spread duration of 4.61%. When looking at the yield volatility of iTraxx Main and comparing it to US 10-year yield volatility, in basis points (bps), we compute the long-term yield volatility of iTraxx Main at 52 bps, while 10-year US Treasuries are at just under 88 bps. So higher yield volatility and higher sensitivity translate to outright higher price volatility.

Figure 1: Major indices total return, Q2 2007 – Q4 2025

Source: Bloomberg, 31 December 2025

It is difficult to look at the returns and the associated volatility of those returns simultaneously in Figure 1. To disentangle the graphic and the more meaningful comparatives, we produce the delivered risk (as computed by the annualised standard deviation of quarterly returns) as well as the delivered annualised return over the 18.75 years. This is shown in Figure 2. If we were to fit a straight line to this dataset, we would observe an upward slope, indicating that there is a positive return to risk. Increase that risk, and it should result in a higher delivered return. The corollary of this is also apparent: a reduction in risk taken will result in a reduced overall delivered return. The textbooks, which have always stated that there needs to be an excess return to risk, are indeed correct.

Figure 2: Major indices risk/return scatterplot, Q2 2007 – Q4 2025

Source: Bloomberg, 31 December 2025

The domination in return terms of US equities, which was touched on earlier in this piece, is quite apparent in the figure, but one must be cognizant of the fact that these indices are shown in local currency. This explains the relatively good performance of the South African Top 40 Total Return index, which is based in rand. In order to do a proper comparative study, we need to translate all the indices into a common currency, and then the comparison becomes more meaningful.

Figure 3 shows the index returns in ZAR, which again shows the domination of US equities over their European counterparts. Questions regarding asset allocators’ offshore exposures are validated by the long-term outperformance of the US risk assets translated into ZAR.

Figure 3: Major indices total return in ZAR, Q2 2007 – Q4 2025

Source: Bloomberg, 31 December 2025

Table 3 shows the compound annual growth rate (CAGR) of the indices in rand from the second quarter of 2007 to date. What is interesting to note is that iTraxx XOver dominates the All Bond Index in total return terms but does so at a significantly higher risk number. Other interesting observations are that US Treasuries underperform local bonds and do so at significantly higher volatility. iTraxx Main (125 equally weighted investment grade European corporate exposures) underperforms our STeFI in terms of total return and does so at significantly higher risk. This should not surprise us as STeFI is inherently a sub-investment-grade credit index, and sub-investment-grade should outperform investment grade due to risk effects. Obviously, the argument could be made that the historic volatility of STeFI approaches zero and is dominated by iTraxx Main volatility in rand, but this misses the as yet unseen volatility, i.e. the inherent kurtosis or surprise factor that is present in sub-investment grade. That kurtosis is amplified by the fact that the STeFI is not a broad-based index (like the iTraxx XOver) and that the surprise factor associated with the South African banking system will be huge. One cannot find any analyst who can currently comprehend the demise of any of the Big Five South African banks. In my view, I would argue that failure is inevitable; the only uncertainty is its timing.

Table 3: Index returns and risk, Q2 2007 – Q4 2025

Source: Bloomberg, 31 December 2025

Moving to the economic backdrop, Figure 4 shows inflation in the developed world (the US, UK, Eurozone and South Africa), highlighting the fact that inflation is well off its highs hit in the fourth quarter of 2022. The fact that the disinflationary trend, which started in the US, seems to have slowed down and even tacitly reversed a tad, has resulted in a more cautious response from the central banks. The European Central Bank (ECB) has essentially completed its interest rate cutting cycle, while the Bank of England’s position is looking rather tenuous. UK CPI at 3.4% is way off the implicit 2% target of the Bank of England, and the bank has effectively run out of room to manoeuvre on short rates. Unless this inflation trend reverses, we might even see interest rate hikes in the UK over the short to medium term. Of course, the UK is in a very distinctive quagmire, with a collapse in growth, triggered by some precarious policy settings coming from the Chancellor of the Exchequer, as well as a cabinet that seems to lack any plans on even formulating plans, which has resulted in a collapse in confidence and the subsequent increased probability of stagflation.

Luckily, the current Bank of England Governor, Andrew Bailey, is quite aware of the political tightrope he is currently balancing on and seems to have placed less emphasis on inflation and is currently paying more attention to economic output and the longer-term potential thereof. This should reduce the likelihood of rate hikes, but if the conundrum continues, the Governor might be forced to do the very thing that he does not want to do. Time will tell. The European Union has finally hit the ECB’s 2% inflation target, and the current headline inflation number of 1.9% may just be tilting the ECB to offer one last cut in 2026.

Figure 4: Annual change in Consumer Price Indices, March 2010 – December 2025

Source: Bloomberg, 31 December 2025

Figure 5: Rand\Oil and scaled CPI year-over-year, December 2023 – December 2025

Source: Bloomberg, 31 December 2025

As stated in the Q3 report, South African headline inflation has essentially already converged on the developed nations’ inflation numbers. We showed that the heavy lifting has essentially given the South African Reserve Bank (SARB) room to cut short-term interest rates more aggressively and essentially showed that the 3% point target was very achievable in this low inflation world. We highlighted that the SARB would continue to cut interest rates into Q4, which they duly did in the November Monetary Policy Committee (MPC) meeting.

The voting was unanimous for a cut. We fully expect the MPC to cut rates again during the first quarter of 2026, and we have pencilled in a 25 bps cut at the January and March meetings. This may appear bullish, but we do feel that the SARB has a proven track record in containing inflation and has earned the right for South African administered rates to compress onto more developed markets. We have therefore revised our short rate expectations lower now to see a further 50-75bps of cuts in 2026 with terminal Repo in the 6.00-6.25% context.

Figure 6 below shows the level of short rates as administered by the US Federal Reserve, the European Central Bank, the Bank of England and the South African Reserve Bank. What is of interest to note is the high levels of correlation in both the direction and the extent of policy movements.

Figure 6: Central bank administered rates

Source: Bloomberg, 31 December 2025

When we start considering rate differentials between the US and SA, as well as inflation differentials between the two countries, we see a position correlation. When inflation differentials (as defined as SA headline inflation year-over-year minus US CPI year-over-year) increase, the interest rate differentials (as defined as SA Repo minus the upper bound of the US Fed Funds Rate) follow suit, increasing in lock step or with a short lag. One could posit, therefore, that as the inflation differential decreases, the interest rate differential should follow more closely.

Figure 7 shows the 15-year history of these differentials, which highlight the level of correlation between the two series. Over the last 15 years, the correlation has been at 0.82. The current inflation differential is at 0.9%, while the interest rate differential is at 3%. Over the 15 years, the average inflation differential is 3.04%, whilst the average rate differential is at 4.97%. So when analysing the monthly difference between these two series, we are looking at an average differential between the two at 1.94%.

The current differential is at 2.1%, giving some additional impetus to at least one rate cut in the first quarter of 2026. It is also important to note that the projections of the SA CPI (Headline) for 2026 are for the current CPI of 3.6% to approach the new target level and to end lower in 2026. The Governor announced in his Monetary Policy Statement that the current SARB projections have them on track to deliver 3% over the medium term.

Figure 7: SA – US inflation and SA – US administered rates

Source: Bloomberg, 31 December 2025

The movements in global bond yields are shown in Figure 8. The 10-year US Treasury, the UK Gilt, the benchmark European Bund and the 10-year South African Government Bond are shown in the figure, albeit using three different scales. It is interesting to point out the high levels of correlation between these four traces, and although short-term disconnects tend to take place, they generally are swiftly reversed.

One issue that might go a long way to explaining the divergence of the South African 10-year yield from the developed yield is the fact that the inflation target has changed. Although this should do nothing to real yields, the effect of the lowering of the inflation average from 4.5% to a point target of 3.0% yields should result in a step movement lower of 150 bps. Since the announcement of the reduction in the inflation target, the local 10-year nominal yield has moved from approximately 10.50% to close the fourth quarter at 8.195%. Arguably, the market has already more than fully discounted the new inflation target. The bond bulls will posit that the rally should consist of a reduction in the inflation target as well as an associated reduction in that inflation volatility, implying that yield movements should be in excess of the 150 bps. Since the said announcement, local bonds have rallied by more than 2.25%, so 1.5% rally for a reduction in inflation and an additional 0.75% reduction due to reduced volatility.

Figure 8: 10 – year benchmark yields in the US, UK, EUR and SA

Source: Bloomberg, 31 December 2025

Table 4 below shows the movements in 10-year benchmark bond yields for the fourth quarter of 2025, the second half of 2025, as well as the calendar year. The table clearly highlights the outsized outperformance of South Africa relative to the US, UK and Euro equivalents. The fourth quarter was the best quarter for SAGBs, where the 10-year yield reduced by some 97 basis points (0.97%), while US and European bonds actually tracked higher in yield by 2 bps and 14 bps, respectively. The table shows the extent of the outperformance of the local market vis-à-vis the global benchmarks.

Table 4: 10 – year benchmark bond yield movements in bps

Source: Bloomberg, 31 December 2025

Fund performance

The strategy of the Fairtree BCI Income Plus Fund (the “Fund”) is to provide investors access to a well-diversified credit portfolio that aims to outperform its targeted return of STeFI Call +2% per annum, within an annualised risk target, as measured by the annualised standard deviation of monthly returns, of less than 3%. This, ex ante, implies a Sharpe ratio of 0.666.

Table 5 shows the total performance of the Fund (Class A) relative to STeFI Call, STeFI Call +2%, the All Bond Index (ALBI) and the Top 40 Total Return Index over various historic periods. The total returns vary from one to 10 years, arguably showing the short-, medium- and long-run performance numbers. Unfortunately, although the inception of the Fund (Class C) is February 2014, the Class A historic pricing on Bloomberg only goes back some eight years. One should also take note that the indices carry no inherent fees, while the Fairtree BCI Income Plus Fund performance is in accordance with Class A, which has a total expense ratio (TER) of 0.90% per annum as currently reported by Bloomberg. This should be borne in mind when considering the relative performance to the other benchmark indices. When one takes this into account, even the smallest investor with the highest fee class has outperformed the Fund’s target over all measurement periods.

It is also important to note that the Fund carries no direct modified duration risk, a stance that has been consistent since the launch date. The Fund does not try to time the bond yield cycle and does not invest in long-dated fixed-coupon securities. The Fund (Class C) has a 10-year correlation with the ALBI of 0.45, which implies an R-squared of 0.20. So around 20% of the volatility of the Fund can be explained by the All Bond Index. The managers feel that if investors do require some modified duration or interest rate risk, they can quite simply take exposure to that risk via investments in a bond fund. Some argue that investors would like managers to take variable risk to the All Bond Index, suggesting that managers have valuable insights into the forecasting of movements of South African Government Bonds. Perhaps they do have shiny crystal balls, but our counter to this is that long-only managers are hamstrung by the fact that they can only play one side of the trade, i.e., they can only buy modified duration risk; they cannot sell it. So, in this regard, the buy-and-hold strategy will probably outperform the trading strategy after all transaction costs.

Table 5: Fairtree BCI Income Plus Fund (Class A) historical annualised total returns to the end of Q4 2025

Source: Bloomberg, 31 December 2025

When looking at Table 5, a few things become apparent.

1. Risk assets have all outperformed risk-free assets over all measurement periods. This might highlight the benefits of a long-term buy-and-hold strategy over a trading strategy. The TOP40TR one-year return number of 46.24% has resulted in large increases over all historic periods. The ALBI annual return of 24.24% in 2025 has also driven ALBI returns over all measurement periods. 
2. The Fund marginally underperformed our previously stated Q4 performance expectation of 2.15%, delivering 2.05% over the quarter.
3. The Fund has delivered 2.94% per annum above STeFI over the past eight years after all fees at an annualised standard deviation of 1.90%.
4. The implied eight-year Sharpe Ratio of the Fund is 1.55. This number compares favourably to TOP40TR and ALBI, which have produced 10-year Sharpe Ratios of 0.37 and 0.43, respectively.
5. The TOP40TR and ALBI have delivered outsized performance figures since Q1 2024.

As highlighted in the observations of Table 5, sometimes an outsized performance in one period can affect all of the longer-dated performance measurements and may sway ones judgement in how the performance has diffused. I would contend that it would be better to receive 10% per year for 10 years than receive 0% for nine years, then a bonsella year of 159%. This number exactly equates to 10% compounded for 10 years. Let us consider the scenario where Fund A produces 10% per annum consistently, while Fund B produces the same 10-year total return but all in the most recent year. The 10-year performance traces of these two distinctive funds are shown in Figure 9. One should note that the two traces end at precisely the same outcome, but the experience of investors in each of the funds is extremely different.

Figure 9: Fund NAV for different performance accumulation 

Source: Bloomberg, 31 December 2025

Now the more interesting point is if we look at the performance numbers of these two synthetic funds after 10 years, which is backward-looking. The reported numbers would look as per Table 6.

Table 6: Reported backward – looking returns (pa)

Source: Bloomberg, 31 December 2025

So, the question now arises, “Which one looks better?”. Optically Fund B looks much better as it has outperformed Fund A over all periods except the 10-year period, which is precisely the same as Fund A. It seems a slam dunk to select Fund B, but the 10-year historic experiences of an investor in Fund A are quite different to the investor in Fund B. Fund A investors have a relaxed experience, while Fund B investors, one could argue, have much more anxiety in monitoring their investments over the full 10-year period. But after the fact, looking backward, a new investor who hasn’t experienced the performance diffusion might be, like captains lured off course by sirens, attracted to the backward-looking reported numbers.

So, the message is that the backward-looking performance numbers sometimes obscure the actual real-time experiences of investors and perhaps explain some behavioural finance errors that they make.

We like to look at performance history in discretised periods. In other words, how did the fund/index do in each discrete calendar year. Table 7 shows the last 11 calendar year discrete performance per year. The Fairtree Income Plus Fund shows Class A, net of all fees, while the indices are obviously gross as they carry no fees.

Table 7: Discrete calendar returns

Source: Bloomberg, 31 December 2025

The Fund has a current weighted average spread to 3-month JIBAR of 218 bps, which sits lower than where it was at the end of Q3. This is primarily due to the fact that the benchmark iTraxx Crossover 5-year spread (Series 44) has reduced by some 20 bps over the period, from 265 bps to 245 bps. With the three-month JIBAR itself having reduced by 25 bps to end the quarter at 6.75%, the Fund’s total yield sits at a reduced 8.93% NACQ. Considering the TER of 0.90%, the Fund is expected to deliver around 2.00% during the first quarter of 2026. This is based upon the continuation of the theme of a low volatility world, and neglects any substantial withdrawal of capital from emerging markets. Should this come to pass, however, the first casualty would be the currency, followed swiftly by SAGBs, which would undoubtedly trade higher in yield, the Fund remains defensively positioned to such an outcome.