Issue: September/November 2008
Editorials

BOND TRADES

Investec Makes a Killing

Was it cleverer than everybody else? Or did it know something they didn’t? Like an impending public storm over the inflation numbers?

There’s no question that Investec Asset Management climbed heavily into the bond market during a few weeks from around mid-June. The buying spree immediately preceded its provocative statement on July 15 that SA’s real consumer-price inflation rate was significantly lower than the Statistics SA calculations being used by the Reserve Bank in determining monetary policy.

The statement triggered, or coincided with, a sharp rise in bond prices. This was especially to the benefit of IAM-managed funds. IAM’s timing on going long, in volumes that exceeded everybody else, was impeccable. Some powerful rivals were caught short.

The question, rather, is whether the extent of IAM buying before release of the statement was motivated by its anticipation of the effect the statement would cause. Yes, contend several IAM competitors who’re hurting because they sold IAM the bonds. No, says IAM, which is laughing all the way to the bank.

For a rough idea of the money that can be made by a buyer, or lost by a seller, take hypothetically a R1bn purchase of the benchmark R157 government bond trading at its highest yield (lowest price) of 10,9% shortly before July 15 and falling by 150 basis points shortly afterwards. Gross profit on the R1bn – not excessive by standards of the bond market, where nominal trading volume can reach R170bn in a day – would show at around R87m over this brief period.

IAM might have bought considerably less or more than R1bn worth. “We don’t know how much IAM actually made from its purchases, because we don’t know their size, but we do have an idea of the losses to a few of the asset managers who sold,” says one prominent market player. “To lose this kind of money in a single month is serious. Guys can lose their jobs. It doesn’t happen often.”

If there’s substance in the competitors’ allegation, then the actions of IAM would look awkwardly close to front-running. Normally bond traders are a pretty discreet bunch, dealing with one another as a fraternity of bankers whose mutual responsibility is to provide the bond market with liquidity, so they’re inclined to keep their frustrations to themselves. But not always. Refer, for instance, to the commentary put out on Bloombergs by Neil Evans of Nedbank shortly after July 15. Rich in innuendo, Evans refuses to elaborate.

By contrast, Andre Roux of IAM is forthright (see below). His explanation carries the hallmarks of plausibility.

Andre Roux

Roux... rich reward

TAKING AIM AT IAM

Investec Asset Management was asked by TT:

  • Was IAM buying bonds heavily, by comparison with, say, the previous three months, during the month preceding July 15?
  • For whom (ie for which IAM client funds or Investec Bank itself) were the bonds bought?
  • What sort of profit would have been made on these purchases?

Andre Roux, IAM head of fixed income and an author of the July 15 statement, replied:

The turnaround in bond markets during July had very little to do with the release of our press article. It would be arrogant of us to think otherwise.

The July rally came after six consecutive months of negative returns in the bond market. This was its longest-ever losing streak. The negativity was driven by global risk-aversion trade, which reversed primarily on the back of the US Treasury’s decision to guarantee Fanny Mae and Freddy Mac mortgage debt securities, plus the Securities & Exchange Commission’s decision to prohibit the short selling of 19 prominent US financials.

These two factors renewed global investor interest in emerging markets. As a result, Turkey, Hungary and Poland rallied strongly, with SA slightly lagging.

Secondly, over a two-week period, commodity prices (particularly maize and oil) corrected heavily. This provided strong support for our bond market. In addition, the rand rallied strongly on the back of potential corporate action.

SA bond yields were further supported by Stats SA’s release, which, we believed, indicated that rates may have peaked. During May this year, our position in bonds went from underweight to neutral, before going long in mid-June. As a result, we underperformed significantly in June. However, we remained convinced that the oil price would moderate and that the global inflation outlook was set to improve. Our positive view was reinforced by the Stats SA numbers at the beginning of July.

We are third-party managers of significant assets in SA and across the globe on behalf of pension funds, unit trusts and corporates. We do not manage any proprietary assets on behalf of Investec Bank. The management of our portfolios is designed to generate long-term returns, not short-term trading profits, so we don’t generate profit/loss figures for individual trades.

IAM did shoot the lights out. This is apparent from the ranking of fixed-interest varied specialist funds on the Glacier platform.

One of the IAM funds, the Investec Flexible Bond Fund, rocketed to first position for the three months to end-July with a 6,05% return. For the six months to end-July, it was ranked 50th with a 1,81% return. Since bonds were hammered during the first two months of the quarter, the exceptional performance would have come mainly from July alone. (Little is known about this fund. There’s no reference to it on the Investec website, suggesting it is not a retail fund open to the general public.)

IAM’s flagship in this same fixed-interest category, the Investec Opportunity Fund, also did particularly well. It moved to third position (with a 4,60% return) for the three months from 15th (with a 5,20% return) for the six months. This was from 21st position (with an 8,56% return) for the year to end-July.

Case for the prosecution: The IAM cpix-inflation statement of July15 transcended the normal cool of economic analysis. It came in the form of a media release whose inflammatory tone and disparaging of Stats SA were designed for maximum publicity and hence for maximum impact, made more certain by the equally forceful response that was inevitable from the Reserve Bank. IAM would have known some time in advance that the statement was to be released, and when it was to be released.

Other market participants, who sold bonds in the weeks before July 15, were caught unawares. The timing of the IAM buying was critical, as was the extent of the buying. In market parlance, it caused some rival asset managers to be “taken out”.

All had access to precisely the same information of developments internationally and domestically that were likely to influence bond prices, except for information of the impending IAM media release.

Case for the defence: Commentary in the July 15 statement was based on information already in the public domain. Particularly topical was the Stats SA announcement on July 1 that it would next year introduce a new cpix inflation series to include such important downweightings as food and electricity. Because of its effect on monetary policy, it was in the public interest that the implications of the current series were researched, interpreted and disseminated.

Interest rates increases affect every citizen and every consumer. If policy formulation before the Stats SA recalculation is based on an outdated cpix series, showing inflation to be higher than it really is, the Reserve Bank would have had stronger reason in August to increase interest rates. In the result, the Bank left rates unchanged. If the publicity generated by the IAM statement contributed to the Bank’s decision, that’s to IAM’s credit. Seeking to influence public policy is its right.

In a commentary published on July 2, Investec stated its expectation that interest rates would not rise in August and that pressure for cuts would begin early in 2009, implying that the market should start pricing in the downward move. Much earlier, in February, IAM put out advice to investors that they should wait for a sell-off in bonds and then buy.

Which case is the more convincing? You decide. One way or another, it’s about your money.