1. How do you determine the credit quality of the investments in the portfolio?

Our proprietary model combines bottom-up and top-down quantitative analysis to arrive at a holistic credit rating for any issuer. When appropriate, we can also apply qualitative judgements to round out our analysis. In addition to our in-house research, we use external bank analysts, rating agencies and independent research houses, both local and international. This ensures that we have interrogated the broadest possible scope of information sources. So while external research is an input into our process, our analysts form their own views and investment decisions are made by the portfolio managers.

A company’s credit rating is debated robustly by our Fixed Income Credit Committee before we determine whether the issuer is investible for us and the appropriate size of our exposure. Our internal ratings are reviewed annually. If an issuer is also rated by one or more official agencies, we will base our judgement on the lower of the two ratings.

2. How do you assess the potential loss of capital in the case of default?

The risk of permanent loss of our capital is referred to as Loss Given Default (‘LGD’), and it is an important part of our holistic risk assessment of any issuer.

We look at an issuer’s credit quality ‘through-the-cycle’. That means that we consider the issuer’s ability to service its debt at the most difficult point of the economic cycle. To estimate the loss that we might suffer if the issuer defaults on its obligations, we carefully consider our position in the issuer’s group structure and whether we are structurally subordinated (i.e. we might own securities issued by the holding company, but our interest payments rely on the cash flows of operating subsidiaries).

We also consider any assets to which we have recourse, in the event of default, and the validity and enforceability of any guarantees. For capital instruments issued by banks and insurers, we consider loss absorbency based on the regulatory frameworks and the buffers to loss absorbency. All these factors help us to assess how severe our loss could be in the event of a default by the issuer.

Each default is unique. Estimating our ability to recover our capital demands a detailed understanding of our security, a forward-looking view of the issuer’s prospects to service and repay debt as well as any other forms of support, such as guarantees from third parties and the potential for shareholders to recapitalise the business.

3. Does your investment process place limits on the portfolio’s exposure to any single issuer or sector of the economy?

We follow a bottom-up, fundamental approach to credit. That means we carefully consider the financial performance of an entity as well as certain non-financial factors (such as environmental, social and governance) in assessing how much debt its balance sheet can sustain. This assessment informs the credit limit applicable to issuers. We also perform periodic top-down reviews of various sectors of the economy to determine the percentage of the fund we are comfortable exposing to a particular sector. 

4. Do you conduct stress tests on your credit portfolio? What scenarios do you consider, and how do you use stress testing to evaluate the resilience of your portfolio under adverse conditions?

We conduct bottom-up stress tests on each of the funds’ credit exposures, based on our assessment of the most relevant credit risks. In the case of MTN, for example, the stress test focused on the sensitivity of MTN Group’s earnings to further devaluation of the Nigerian Naira.

These stress tests inform our funds’ appetite to increase exposure to certain credits, the STANLIB internal rating for credit exposures as well as the additional yield we might require to justify additional exposure.

The portfolio management team also conducts liquidity stress tests on the portfolios to understand how quickly they can liquidate credit exposures if adverse conditions result in significant withdrawals of liquidity. These stress tests inform whether fund liquidity should be increased (high likelihood of an adverse event), maintained or decreased (low likelihood of an adverse event).

5. How often do you update the value of your credit positions?

Credit instruments are valued on a mark-to-market basis, based on Johannesburg Stock Exchange (JSE) pricing. We deviate from this principle in the case of defaulted credit assets, on which we apply an internal valuation model based on our internal credit rating and our expectations of the issuer’s restructured cash flows. The STANLIB Valuation Committee and our external auditors oversee this internal valuation model.