Fitch affirms Ceylon Gilt-Edged Fund at ‘AAA’/’V1(lka)’
Thursday, 10 October 2013 00:00
Fitch Ratings has affirmed the Ceylon Gilt-Edged Fund’s ‘AAA(lka)’ National Fund Credit Rating and ‘V1(lka)’ National Fund Volatility Rating. The fund is managed by Ceylon Asset Management (CAM).
Key rating drivers
The ‘AAA(lka)’ National Fund Credit Rating is driven by the fund’s investment in Government securities and repurchase agreements backed by Government securities only. Fitch considers the national credit quality of Sri Lankan Government securities to be ‘AAA(lka)’.
The key rating driver for the ‘V1(lka)’ National Fund Volatility Rating is the fund’s investment in government securities only, with a maximum maturity of one year. As a result, the fund incurs low interest rate risk and negligible spread risk in the context of the Sri Lankan market.
The fund is small, both in relative and absolute terms. It has also suffered volatile investor flows. Both of these factors pose risks - notably operational - to the fund and the manager. Fitch believes these risks are mitigated by CAM’s familiarity with operating small funds, as well as by the duration-matching techniques used to manage investor flows.
Asset credit quality: The portfolio is exposed to Sri Lanka Government debt instruments and repo backed by government securities. Consistent with Fitch’s view that the credit risk of Sri Lankan government securities is ‘AAA(lka)’ the fund is therefore of equivalent credit quality. Repo contracts are over collateralised. The repo contract held at end-September 2013 was over collateralised by 7%.
Portfolio sensitivity to market risk: The fund invests only in short-dated government securities and repos backed by such securities. As a result in a national context its sensitivity to market risk is very low. The fund seeks to provide duration-matched investment strategies for its investors, i.e. investors enter the fund with a specified maturity target which is matched to the maturity of securities in the fund. These duration-matched holdings are not subject to early redemption restrictions. Fitch considers, however, that the liquidity provided by the secondary market in Sri Lankan government debt and the 30-day advance notice required for redemptions greater than 3% of fund assets is sufficient to justify a ‘V1(lka)’ National Fund Volatility rating.
The advisor: Fitch considers CAM suitably qualified, competent and capable of managing the fund. The investment committee has adequate experience and the company has sufficient sources of information on which to base its decision-making process. Fitch considers the systems supporting the fund’s investment activities satisfactory.
CAM is 25% owned by Sri Lanka Insurance Corporation Ltd. (SLIC, AA(lka)/ Stable) and 75% by Ceylon Capital Trust Ltd. The business has struggled to generate sustained growth in assets under management (AuM). Nonetheless, Fitch believes it has support from shareholders. CAM has been in existence and managing funds since 1999. The current management team has been in-place since 2005 and SLIC invested in the business in 2010.
As of end-September 2013 Ceylon Asset Management employed 11 staff members. Securities and Exchange Commission of Sri Lanka data as of December 2012 indicated that CAM had a small market share. Fitch expects that, despite its small size, the Sri Lankan unit trust industry will continue to grow, supported by regulatory initiatives. Given the small sizes of CAM and of the fund relative to the Sri Lanka industry, Fitch will monitor both the fund and asset manager closely.
Fund profile: The fund is regulated by the Securities and Exchange Commission of Sri Lanka under the Unit Trust Code, 2011. The fund’s trustee is Deutsche Bank Sri Lanka, a branch of Deutsche Bank AG (‘A+/Stable/F1+’). The fund was launched in April 2012. The fund has grown since Fitch assigned rating in May 2013, but total AuM are still below the peak achieved in July 2012 and shareholders in the fund were highly concentrated.
Funds in the ‘AAA(lka)’ rating category are considered to have high underlying credit quality relative to other entities in the Sri Lankan market. The fund’s assets are expected to maintain a weighted-average portfolio rating of ‘AAA(lka)’.
Funds in the ‘V1(lka)’ rating category are considered to have very low sensitivity to market risk. On a relative basis, total returns are expected to exhibit high stability, performing consistently across a broad range of market scenarios. These funds offer very low risk exposure to interest rates, credit spreads and other risk factors. The fund’s assets are expected to maintain a Volatility rating of ‘V1(lka)’.
Comparisons between different national fund rating scales or between an individual national and international scale are inappropriate.
The ratings assigned to the fund may be sensitive to material changes in its credit quality or investment guidelines. A material adverse deviation from Fitch criteria for any key rating driver could cause ratings to be downgraded. The rating is also sensitive to Fitch’s view that Sri Lankan Government securities are the lowest relative risk in Sri Lanka. A change in this view could cause Fitch to downgrade the rating consistent with its revised view on the relative credit worthiness of Sri Lankan Government securities.
The fund has struggled to build a diversified investor base and, since the rating was assigned in May 2013, has consequently reported highly volatile investor flows. Fitch considers a stable, diversified investor base and a reasonable number of assets held in the portfolio as significant components in developing an operationally manageable fund. Should the fund fail to achieve a stable, diversified investor base and a wider spread of holdings over the next six months, then Fitch may conclude that the rating on the fund is not relevant to the agency’s coverage and withdraw its rating.
For additional information about Fitch rating criteria applicable to bond funds, please see the criteria referenced below, which can be found at www.fitchratings.com.