Fairtree BCI Income Plus Fund Q3 2025 Commentary

Market dynamics

Global Risk

The bull market, which started at the beginning of the second quarter, continued unabated into the third quarter of 2025 with North American equities rallying strongly. The large-cap Dow Jones Industrial Average delivered 5.67% to investors, whilst the broader S&P 500 outshone that, producing a rather pleasing 8.11%. But the star of the show yet again was the tech-heavy NASDAQ, which increased its value by some 11.43% in the 14th best showing since Q2 2007. When one considers that this index was actually down some 10.26% after the first quarter, the recovery of this index to its current +17.96% on a year-to-date basis is nothing short of remarkable. If we consider that over the last two quarters the NASDAQ has delivered around 31.45%, one starts to realise the risk of not being invested in risk. The combination of the second and third quarters of 2025 is the fourth-best rolling six-month performance of the NASDAQ since Q2 2007.

The best performing rolling six-month period occurred post the COVID-19 announcement and occurred in Q2-Q3 2020 when the world was in strict lockdown, i.e. masks, social distancing, no visitors or excessive exercising, no driving cars and a whole lot of other Orwellian measures. During this period, investors in the NASDAQ witnessed a 45.65% increase in the market value of their assets. One could surmise that the ex-post probability of these excessive returns during that period was a rounding error from zero. The most recent six-month period, post the introduction of “Global War on Tariffs”, would also have surprised the risk bears out there in that the more recent outsized returns would also have been deemed equally unlikely. But unfortunately (or fortunately), financial markets don’t really conform to “obvious” forecasts; in fact, it is seldom that the NASDAQ has delivered a negative return over six months. Over the last 73 rolling six-month periods only 19 (26%) produced a negative return. That infers that 74% produced positive returns, or it was almost three times more likely to produce a positive rather than a negative outcome. Investing certainly comes with risk, but perhaps concentrating on the risk side of investing leads us to avoid the positive outcomes of remaining invested, and this seems to also be the case in the short run.

Table 1 below shows the ranked performance of the popular risk indices. The rankings are over the last 74 quarters and highlights the broad-based rally across the globe. It was only the DAX which delivered a red number whilst the other indices were comfortably in the black. Even the FTSE 100 delivered 7.51% or the 11th best quarter since Q2 2007.

Table 1: Major Index Q3 2025 total return and historic rankings Q2 2007 – Q3 2025

Source: Bloomberg, 30 September 2025

Moving to European credit, the iTraxx suite of indices produced another set of numbers that were quite meaningful. The iTraxx Crossover 5-year Total Return Index produced another good quarter, posting 2.34% which outperformed European cash quite comfortably. Our more favoured two-times levered index, a more realistic measure of the risk-adjusted relative performance of European credit, produced a healthy 4.20% 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. This aversion to catastrophic loss is probably the main driver of the very excess returns that the indices have produced since inception. One could suggest that the return to normality might undo this excess return, but our view is that the average investor has little to no appetite for taking such a risk. This play ensures that risk premium remains elevated and is the very reason for the persistence of this excess return through time.

Given that we have over 18 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 received. 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 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, but we feel that the basic return per unit risk ratio is a good proxy for the slightly more rigorous SR measure. Obviously, a higher number is better as the investor receives more return for his 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. By way of an example, it might be foolish to buy an index that produces a 0.4% annual return with 0.2% annualised volatility – a return coefficient of 2; rather than an index that produces a 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 prevailing currency and therefore is not a measure of “excess return” but rather total return.

From a European perspective, Table 2 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 an investor is 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 risk-adjusted gap to US equities. It is also important to note that these numbers are all based on local currency and do not necessarily reflect the experience of an investor from a specific domicile. Arguably, a dynamic currency hedging regime, to mitigate currency effects should do nothing to realised risk, but should have an effect on the annualised return numbers, as currency hedging programs are effectively cross-currency interest rate swaps, i.e. float-float swap. This could be modelled as the integral of the differences in short rates over the period in question.

Table 2: Index risk-adjusted return co-efficient

Source: Bloomberg, 30 September 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 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 returns to risk-free. The worst performing traces over the 18.5 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 lowest risk 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 18.5 years.

Figure 1: Major Index total return Q2 2007 – Q3 2025

Source: Bloomberg, 30 September 2025

It is difficult to look at the returns and the associated volatility of those returns simultaneously in Figure 2. 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 18.5 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.

It remains obvious that the short run (each quarter) 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. Investors who extrapolate the short-term lines do so at their peril in that to presume that the NASDAQ can continually produce +11% per quarter should result in disappointment. It is, however, interesting to note that the aforementioned NASDAQ does seem to adapt to the ever-changing economic environment more quickly than more mainstream industrial indices, such as the Dow Jones and that North American equity indices seem more adaptable than their European and UK equivalents. This might be due to the underlying economic landscape in which those indices operate on. One might posit that the US is more “geared” to growth, and legislation in the US is more market friendly. One might argue that the social/capital balancing point is slightly more skewed to the capital side of the economic seesaw. We feel that this has even further ramifications across company balance sheets in that the favourable dynamics to capital will also influence the risk-reward dynamics within companies themselves. Favourable equity conditions are bad for the debt portion of company balance sheets. This is one of the main reasons why our credit fund suite remains overweight European credit, whilst underweight North American credit.

Arguably, FX effects are ignored, but we strongly believe that FX risks and rewards should be fully hedged in a credit portfolio, as the risk of that FX dominating the risk of the index that one is trying to mirror or enhance.

Figure 2: Major Index Risk Return scatterplot Q2 2007 – Q3 2025

Source: Bloomberg, 30 September 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 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. Questions regarding asset allocators’ offshore exposures are obviously validated by the long-term outperformance of the US risk assets translated into ZAR.

Figure 3: Major index total return in ZAR Q2 2007 – Q3 2025

Source: Bloomberg, 30 September 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 has essentially completed its interest rate cutting cycle, whilst the Bank of England’s position is looking rather tenuous. UK CPI at 3.8% 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 run. After the prolonged spat between the Federal Reserve and the US President, the Fed cut interest rates for the first time in 202 during the third quarter. We remain largely bullish on the potential for more cuts from the Fed before bottoming somewhere in the 3.50 – 3.75% context.

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

Source: Bloomberg, 30 September 2025.

As was stated in the Q2 report, South African headline inflation has essentially already converged on the developed nations’ inflation numbers. We showed that the heavy lifting has 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 a low inflation world. We highlighted that the SARB would continue to cut interest rates into Q3, which they duly did in the July Monetary Policy Committee (MPC) meeting. The voting was unanimous for a cut. We fully expected the MPC to cut again during the September meeting and were even more convinced after the Federal Reserve had finally decided to cut rates in their September meeting. This was their first cut in 2025 after the last cut in their December 2024 meeting. We were very surprised that the MPC decided to keep rates on hold in a 4-2 voting split. This stop-start cutting cycle, although perhaps warranted, might result in more uncertainty for economic actors within our borders in that the policies might appear to be more focused on the short run than the longer-term prognosis for local inflation. We do remain bullish on short rates, expecting another 50-75 bps through this cycle with terminal repo bottoming between 6.25-6.50%.

Figure 5 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 as well as the extent of policy movements.

Figure 5: Central Bank administered rates

Source: Bloomberg, 30 September 2025.

The movements in global bond yields are shown in Figure 6. The 10-year US Treasury, the UK Gilt, the benchmark European Bond, 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 are generally 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 be a step movement lower of 150 bps. The local 10-year nominal yield has moved from approximately 10.50% to close the quarter at 9.16%. Arguably, the market has already fully discounted the new inflation target, which unfortunately leaves the bond bulls looking for a valid economic rationale to extend the yield line lower. We remain of the view that local bond yields are fairly priced and are offering low relative value at this juncture.

Figure 6:  10-year benchmark yields in the US, UK, EUR and SA

Source: Bloomberg, 30 September 2025.

Fund performance

The strategy of the Fairtree BCI Income Plus Fund (“Fund”) is to provide investors access to a well-diversified credit portfolio that aims to outperform its targeted return of STeFI call deposit rate plus 2% p.a. over the long term, 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 1.

Table 3 shows the total performance of the Fund relative to STeFI call deposit rate plus 2%, the All Bond Index (ALBI), as well as the Top 40 Total Return Index over various historic periods. The total returns vary from one month to 10 years, arguably showing the short, medium and long run performance numbers. One should take note that the indices carry no inherent fees while the Fund performance is in accordance with Class C, which has a total expense ratio (TER) of 0.65% per annum, as currently reported by Bloomberg. This should be borne in mind when considering the relative performance to the other benchmark indices.

The other notable fact is that the Fund carries no direct modified duration risk, a stance that has been consistent since the launch date. The Fund has a 10-year correlation to ALBI of 0.54, which implies an R-squared of 0.29. So around 30% 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 3: Fairtree BCI Income Plus Fund (Class A) historic annualised total returns to the end of Q3 2025

Source: Bloomberg, Fairtree, 30 September 2025

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

1. Risk assets have all outperformed risk-free over all measurement periods. This might highlight the benefits of a long-term buy-and-hold strategy over a trading strategy. The TOP40TR delivered a strong one-year return of 32.39%, and over the past 10 years has generated an annualised excess return of 3.62% above the STeFI +2% benchmark.

2. The Fund beat our previously stated Q3 performance expectation of 2.35%, delivering 2.76% over the quarter.

3. Over the past 10 years to 30 September 2025, the Fund delivered 0.75% per annum above the STeFI +2% benchmark after fees, with an annualised standard deviation of 1.77% (10 years to 30 September 2025).

4. The implied 10-year Sharpe ratio of the Fund is 1.41. This number compares favourably to TOP40TR and ALBI, which have produced Sharpe ratios of 0.31 and 0.34, respectively.

5. The TOP40TR Index and ALBI have delivered outsized performance figures since Q1 2024.

Looking to the fourth quarter of 2025, the bull run that we have witnessed year-to-date looks to be drawing to a close, and for investors who look to extend the trend, they must be cognisant of the fact that more than two-thirds of the excess total return against STeFI of the TOP40TR index has been borne over the last 18 months. This may indicate that the bull market must be waning. The All Bond Index, at 69%, looks even worse and one should probably consider risk allocation to the asset class carefully before deploying more capital. The Fund showed a more consistent proportional gain over the last six quarters, with only 18% of its 10-year historical total return being attributed to this time period.

The Fund has a current weighted average spread to 3-month JIBAR of 226 bps, which sits lower than where it was at the end of Q2. This is primarily due to the fact that the benchmark iTraxx Crossover 5-year spread (Series 43) has reduced by some 41 bps over the period. With 3-month JIBAR itself having reduced by 29 bps to end the quarter at 7.00%, the Fund’s total yield sits at a reduced 9.26%. Considering TER of 0.90% as of June 2025, the Fund will probably deliver around 2.15% during the fourth quarter. This should result in a calendar year 2026 performance of around 10.80%. This obviously 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 for such an outcome.

The Fund added around 3.1% to bank issued short-dated money market instruments, 3.5% to Government Guaranteed TransNet, 0.7% to new Asset Back Securities, 1.4% to Absa Tier 2 subordinated debt and about 1.2% to a new five-year bond issued by Santam. The total turnover in the Fund was around 10% during the third quarter, and this perhaps vindicates the lack of liquidity presumption in the South African credit market.