Market dynamics
Global Risk
It was a complete turnaround in the fortunes of global equities in the first quarter of 2025. The 47th US President was sworn in during the period, and contrary to popular opinions, the US stock market took a bit of a beating from a relative perspective. The Large Cap Dow Jones Industrial Average lost some 0.87% whilst the tech-heavy NASDAQ lost some 10.26% over the period. Several reasons have come through for this, but more than anything else, it was an excuse the market needed to bring the North American equity indices a little lower in price. One must sometimes remember that the PE ratio of the NASDAQ as at the end of December 2024 was at 40.25 and has derated to 32.4. When one considers that the best performer over the period was the Dax, which delivered over 11%, most of this outperformance was due to a re-rating of its PE, which increased from 16.6 to 17.8 times. This amounted to around 7% in total return, the additional four or so percent coming through from increased earnings. The de-rating of the NASDAQ would have subtracted some 19.5% of return, so obviously the differential has come through increased earnings from that index. All very poignant when one considers what can happen if PE ratios normalise from a global perspective. Table 1 below shows the PE ratios of the major equity indices as at the end of Q4 2024 and Q1 2025.
Table 1: Major Index Price Earnings Ratios Q4 2024 – Q1 2025
Source: Bloomberg, 31 March 2025
Moving to European credit, the iTraxx suite of indices produced another set of numbers that were marginally in the black. The iTraxx Crossover 5-year Total Return Index produced a meagre 0.37%, which underperformed cash at the margin, whilst the 2 times levered index, our more favoured measure of the relative performance of European credit, produced a rounding error from zero at 0.02% for the quarter. These were not particularly great from a historical point of view. Yes, they did remain positive, but only just. From a persistence perspective, one must return to the 2nd quarter of 2022 to find a negative total return from the iTraxx Crossover. For the first time since Q1 2024, the DAX, the FTSE 100, the SX5E and the CAC 40 outperformed the iTraxx Crossover in total return terms. In fact, of the last 72 quarters, only 22 of those quarters have witnessed European equities outperforming the credit index. When one looks at more of a like-for-like in risk terms by using the 2x levered XOver, that number drops to 14. Just to reiterate what this means, in the last 18 years of quarterly data, European equities have only outperformed the 2 times levered iTraxx XOver index on 14 occasions.
Table 2: Major Index Q4 2024 Total Return and historic rankings Q2 2007 – Q1 2025
Source: Bloomberg, 31 March 2025.
Given that we have 18 years of quarterly data, we can do more than just look at the outright performance numbers and the relative rankings. We can also 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 for one investor is 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. The simple calculation of mean divided by standard deviation gives a good measure of risk-adjusted return, which 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 their accumulated risk. 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 3 shows the annualised returns, the annualised risk, and the return coefficients for the major indices we monitor. These numbers are generated from our historic dataset and therefore do include risk periods such as the Global Financial Crisis (GFC), the Greek Government default crisis, the COVID 19 global pandemic, the more recent Ukraine/Russian War as well as the current war in the Middle East and all the political turmoil in Europe the UK and the United States. Perhaps it is more of the same rather than the exception now, with the world as usual teetering on the brink of the potential for some financial fallout. Still, traditionalists would suggest that this potential for fallout is the very reason that risk premia exist in the first place. No risk should have risk-free returns; those who choose to take the risk of loss should surely be rewarded for doing so. This line of argument would go a long way in explaining persistence in market returns, the “overvaluation” of US equities has been bandied around for the last 2 decades, and yet they continue to outperform their European counterparts. Contrary to popular opinion, the outperformance will more than likely continue until participants accept it as the “new normal”, and when that eventually happens, it will probably be followed by a reversal of fortunes. The relative performance of Europe over the 1st quarter of 2025 is a moot point, but one will need to see a lot more persistence of this to conclude about the “dawning of a new era”. Perhaps, as is always the case in statistics, they perfectly explain the past but say absolutely nothing about the future. In accepting this, one realises that solid views still need to be taken to profit from any market dislocation or relocation. Time will be a fantastic teacher in this regard.
From a European perspective, Table 3 highlights the outperformance of credit from a risk-adjusted perspective. In fact, the more risk normalised two times levered index solidly outperforms its equity equivalent, offering investors excess return for a given risk target. If investors are comfortable with equity-type risk, they should be more than happy with the extra return that iTraxx*2 has offered. This index goes a long way to close the relative gap to US equities, that gap has closed somewhat during Q1, and provides a rather good fund diversifier to the allocator that has a US strategic overweight.
Table 3: Index Risk Adjusted Return Coefficient
Source: Bloomberg, 31 March 2025
As an extension of last quarter’s report, Figure 1 below shows the cumulative return of the various indices in the currency of the index domicile. The various performance traces were indexed to 100 at the beginning of the second quarter of 2007, when we had complete historic data for the iTraxx XOver and Main total returns.
Figure 1 also shows that there are no returns to risk-free. The worst-performing traces over the past 18 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 years.
Figure 1: Major Index Total Return Q2 2007 – Q1 2025
Source: Bloomberg, 31 March 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) and the delivered annualised return over the 18 years. This is shown in Figure 2. If we fit a straight line to this dataset, we would observe an upward slope indicating 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. The short run is deemed to be random, whilst the longer run will yield excess return due to the extraction of the various risk premia. As time elapses, the risk premium (or positive slope) becomes more apparent. One heuristic would be that the short run is randomly distributed around a mean and variance, whereas the longer run is an equally weighted “portfolio” of those independent periods. Thanks to the only free lunch in finance, i.e. the Central Limit Theorem, the long run results in a normally distributed outcome centring on that delivered risk premium. Mathematics delivers to investors what economists can only posit.
Figure 2: Major Index Risk Return scatterplot Q2 2007 – Q1 2025Source: Bloomberg, 31 March 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 that these indices are shown in local currency. This explains the relatively good performance of the South African Top40 Total Return index based on the Rand. 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. The long-term outperformance of US risk assets translated into ZAR obviously validates questions regarding asset allocators’ offshore exposures.
Figure 3: Major Index Total Return in ZAR Q2 2007 – Q1 2025
Source: Bloomberg, 31 March 2025.
Moving to the economic backdrop, Figure 4 shows inflation in the developed world (US, UK, Eurozone and South Africa), highlighting that inflation is well off its highs hit in the 4th quarter of 2022. The fact that the disinflationary trend, which started in the US, seems to have slowed down and has resulted in a more cautious response from the central banks. What is interesting to note is that the convergence of South African headline inflation to the developed nations might have indicated that there is some extra room for the SARB to consider more aggressive cuts, certainly from a relative perspective. To date, the SARB has been overly cautious and missed the opportunity to cut rates more aggressively. We believe that the window of opportunity may have closed already, with inflation picking back up to around 3.2% from a low of 2.8%. It would be difficult for the governor to cut rates now that inflation is rising, and perhaps with the backdrop of increased VAT, with its spillover into inflation numbers, it will be even more difficult for the MPC to continue with the cutting cycle. The other issue is that the ZAR has weakened dramatically over the short run and given the fact that around 605 of the inflation baskets is ZAR related, the prospect for higher inflation looms in 2025. To add further headwind, there is the talk of reducing the inflation target band itself, which will require higher real rates for South Africa to transition to a lower band. All these factors have resulted in the change of our central case from further cuts to no cuts.
Figure 4: Annual change in Consumer Price Indices March 2010 – March 2025
Source: Bloomberg, 31 March 2025
Figure 5 below shows the short rates 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. The other point to highlight is that the response from the SARB has been the most restrained in terms of timing and extent. The Fed has cut by 100 bps, the ECB 185 bps, the BOE 75 bps and the SARB 75 bps, albeit off a much higher base. As was previously stated, we will now contend that the window for further rate cuts has now closed, but remain cognisant of the current environment where the market is discounting some 100-125 bps of cuts by the Fed by Q1 2026. However, we believe that those excesses will be taken out of market prices over the next quarter, as the “Tariff War” premium unwinds.
Figure 5: Central Bank Administered Rates
Source: Bloomberg, 31 March 2025
The movements in global bond yields are shown in Figure 5. The 10-year US Treasury, the UK Gilt, the benchmark European Bund, and the 10-year South African Government 10-year 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 that although short-term disconnects tend to take place, they generally are swiftly reversed. Bearing this in mind, one can see that the current yield on the generic 10-year SA bond is probably unsustainable. It does not take much by the way of imagination to see that the bond is currently trading at too low a yield from a relative perspective, and local bulls should be aware that the more short term outperformance of the local asset class is not based on global fundamentals, and that those relative valuations will be the determining factor of where yields find their equilibrium level. Of course, it does take all types to make a market, and the current price is real, we should therefore be cautious have having too strong a view on such matters as “betting the farm” on one’s views on current valuations is never a great strategy, but small tactical overweight /underweights must be based on something.
Figure 6: 10-year benchmark yields in the US, UK and SA
Source: Bloomberg, 31 March 2025
Fund Performance
The fund’s strategy is to provide investors access to a well-diversified credit portfolio that aims to outperform its targeted return of STeFI+3% over the long term, within an annualised risk target of less than 3%, as measured by the annualised standard deviation of monthly returns. This, ex ante, implies a Sharpe ratio of 1.
Table 4 shows the total performance of the Fairtree BCI Income Plus Fund relative to STeFI, the All-Bond Index (ALBI), and the Top40 Total Return Index over various historical periods. The total returns vary from 1 month to 10 years, arguably showing the short, medium, and long run performance numbers. One should note that the indices carry no fees, while the fund performance is in accordance with Class A, which has a TER of 0.90% per annum, as reported by Bloomberg. When one observes the table, it is pretty apparent that the Fairtree BCI Income Plus Fund has delivered very stable annualised performance numbers across all time periods, both from an absolute as well as a relative basis.
Table 4: Fairtree BCI Income Plus Fund historic annualised total returns to end Q1 2025
Source: Bloomberg, 31 March 2025
When analysing the table, a few things become quite apparent, and even a touch startling.
- The fund had a rather pedestrian first quarter of 2025, generating 2.09% on an outright basis whilst outperforming STeFI by 0.20% on an after-all-fees basis. This was below our expectations of 2.35% for the quarter.
- The fund has delivered more than 3.17% per annum above STeFI over the past 5 years and more than 2.01% excess return per annum over all measurement periods.
- Despite its defensive positioning, the fund has outperformed STeFI by around 2.01% on the most recent rolling 1-year basis.
- The fund exceeded its target over the last two years, delivering over 4% excess return to STeFI per annum and outperforming both the ALBI and the TOP40 Total Return Index.
Looking to the 2nd quarter of 2025, the weakness in global credit markets has allowed us to increase the fund’s risk, and the spread to 3-month JIBAR has increased to some 260 bps. With the 3-month JIBAR having reduced to 7.55%, the current yield of the fund is around 10.15% on a pre-fees basis. Subtracting the TER of 0.90% results in a pro forma 12-month outlook of around 9.5%. This, of course, is our central case, and there is a distribution around this number. Of course, the fund will be affected by the trials and tribulations of global credit markets. Still, given the fact that the fund is currently defensively positioned, the managers will continue to nibble high-yielding assets into any weakness.
Looking a bit further out, 1-year swaps closed the quarter almost unchanged from the previous quarter at 7.40%, so prospectively the fund should deliver just under 10% on a pre-fees basis, and around 9.4% on a post-fees basis. Regarding rate cuts, our central case is that the current global market volatility will subside, and that the SARB will continue to show reluctance to cut rates further, the window of opportunity has probably been missed and that it will be difficult for the MPC to cut rates into an increasing inflation backdrop. We therefore expect that, barring some global calamity, the next major move in interest rates will be higher. Our previous view was constructive on short-term rates, but we now feel that the more recent narrative coming from the Reserve Bank Governor regarding the lowering of the inflation target will require higher real rates in the short run, again reinforcing the argument for stable rather than lower rates. We can only go on the word of the Governor, obviously if they re-institute the cutting cycle, cutting by a further 75 bps or so, bonds will perform well whilst the fund yield will drop on a 1 for one basis. This remains our risk case from an outright and relative basis. We continue to stay true to our mandate, avoiding the temptation to start increasing the interest rate duration of the fund, as this is outside the scope of what we usually do and would be incongruent with our expected investment thesis.
Looking to the second quarter, the markets will be jostling with the potential of continued global political instability. The backdrop remains fluid, with managers facing the conundrum of increasing portfolio risk in an ever-increasing risky backdrop. For those who have the capacity to take on more risk, this may prove to be a wonderful opportunity. Still, unfortunately, as is normally the case, most managers were already fully invested in the sell-off and do not have the means or the appetite to buy into further weakness. Luckily, due to our disciplined approach to beta exposure, we have ample liquidity in the fund, which will be deployed as the opportunities present themselves. The portfolio will be reshaped in any prolonged or temporary bear market
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Disclaimer
The highest calendar year return was 13.06%, and the lowest calendar year return was 5.58% (information as of 31 March 2025). The fund has returned an annualised return of 9.03% since inception (12 March 2014) (Benchmark return: 8.27% since inception).
Fund returns disclosed are annualised returns net of investment management fees and performance fees. Annualised return is the weighted average compound growth rate over the period measured. The information in this two-pager is provided as a general summary only. Past performance is not necessarily a guide for future performance. Fund investment risk indicator level: conservative. Actual investment returns are available on request. The investment Performance is for illustrative purposes only. The investment performance is calculated by taking the actual initial fees and all ongoing fees into account for the amount shown, and income is reinvested on the reinvestment date.
Boutique Collective Investments (RF) (Pty) Ltd (“BCI”) is a registered Manager of the Boutique Collective Investments Scheme, approved in terms of the Collective Investments Schemes Control Act, no 45 of 2002 and is a full member of the Association for Savings and Investment SA.
Collective Investment Schemes in securities are generally medium- to long-term investments. The value of participatory interests may go up or down, and past performance is not necessarily an indication of future performance. The Manager does not guarantee the capital or the return of a portfolio. Collective Investments are traded at ruling prices and can engage in borrowing and scrip lending. A schedule of fees, charges and maximum commissions are available on request. BCI reserves the right to close the portfolio to new investors and reopen certain portfolios from time to time in order to manage them more efficiently. Additional information, including application forms, and annual or quarterly reports can be obtained from BCI, free of charge.
Performance figures quoted for the portfolio are from Morningstar, as at the date of this document for a lump sum investment, using NAV-NAV with income reinvested and do not take any upfront manager’s charge into account. Income distributions are declared on the ex-dividend date. Actual investment performance will differ based on the initial fee charge applicable, the actual investment date, the date of reinvestment and dividend withholding tax.
Investments in foreign securities may include additional risks, such as potential constraints on liquidity and repatriation of funds, macroeconomic risk, political risk, foreign exchange risk, tax risk, settlement risk as well as potential limitations on the availability of market information.
Boutique Collective Investments (RF) Pty Ltd retains full legal responsibility for the third-party named portfolio.
Although reasonable steps have been taken to ensure the validity and accuracy of the information in this document, BCI does not accept any responsibility for any claim, damages, loss or expense, however, it arises, out of or in connection with the information in this document, whether by a client, investor or intermediary. This document should not be seen as an offer to purchase any specific product and is not to be construed as advice or guidance in any form whatsoever. Investors are encouraged to obtain independent professional investment and taxation advice before investing with or in any of BCI/ Manager’s products.
Access the BCI Privacy Policy and the BCI Terms and Conditions on the BCI website (www.bcis.co.za). A portfolio that derives its income primarily from interest-bearing instruments in accordance with Section 100(2) of the Act, whether the yield is historic or current, as well as the date of calculation of the yield.
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