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IMPACT OF CORONAVIRUS (COVID-19) AND THE RATINGS DOWNGRADE ON THE EPPF INVESTMENT PORTFOLIO

03 April, 2020

Investment performance is impacted, either negatively or positively, by a number of factors on the global and local fronts. Globally, the Coronavirus pandemic is having a huge effect on the economy worldwide - resulting in a slowdown of global markets. Locally, the announcement of a sovereign credit ratings downgrade of South Africa to non-investment grade level by ratings agency Moody's Investor Service will have far-reaching consequences for the local economy and, by extension, the investment portfolio of the EPPF. The EPPF, as one of the largest institutional investors on the African continent, has exposure to most sectors of the South African economy. As such, our investment portfolio, like many others, will unfortunately not be spared from this slowdown in the global economy.

Following these major events in the financial markets, the EPPF investment team has put together a detailed analysis of the impact of the coronavirus and sovereign credit downgrade on the SA economy and on EPPF investments.

COVID-19 OUTBREAK

The 2019-2020 coronavirus (COVID-19) outbreak is a public health emergency that is officially recognised as a global pandemic by the World Health Organization (WHO). It was first discovered in December 2019 in Wuhan, Hubei district, People's Republic of China. As of 23 March 2020, the reference date of this message, more than 300 000 cases of infection have been confirmed in over 150 countries and over 9 000 people have died.

One of the pandemic's most notable properties is how easily it spreads, typically with the infected host being contagious without exhibiting any symptoms at the early stages. Countries have thus moved into lock-down, international travel has ground to a halt and healthcare facilities are ramping up operations in anticipation that public and private health facilities will be overwhelmed in the coming months as the pandemic spreads. The number of confirmed fatalities may seem benign at this point, but exponential growth is likely if societies don't adapt their behaviour to slow the spread of the virus. Currently, there are no proven drugs or vaccines to stop infections.

GLOBAL FINANCIAL MARKETS

From late December 2019 to the last week of February 2020 investors in financial markets had a mixed response to the outbreak of the virus, with some markets pricing in global economic slowdown more aggressively than others. Largely, market participants appeared to price in a central scenario in which new cases of infection would slow (i.e. Two months from mid-February 2020). This picture changed sharply.

From the last week of February 2020, financial markets have completely repriced pandemic risks, with global equity markets experiencing a large loss of value. We have also seen less risky assets like developed markets bonds showing positive gains. Emerging market bonds and currencies (like South African bonds and the Rand) have sold off as these are considered risky assets. These market moves came right after a surge in new cases reported outside China - in Italy, Iran, South Korea and Japan (to mention the most notable at the time).

Investors are now grappling with the impact that a full-scale pandemic will have on global growth. The repricing of risky assets has continued and been very broad, with little evidence that investors are differentiating by sector, company or region. This financial crisis is similar in severity to the global financial crisis in 2008.

THE FUND

The Fund's assets were R146.2bn on 31 December 2019 and had fallen to R114.1bn on 23 March 2020, which is a 21.94% decline. However, our portfolio performed better than the Strategic Asset Allocation (SAA) Benchmark, which fell 23.19%. The table below shows the impact (in ZAR currency) of the COVID-19 (Coronavirus) on the various asset classes as measured by the movements in benchmark indices from 31 December 2019 to 23 March 2020. These movements are viewed in the light of the peak-to-trough fall in asset prices during the 2008 global financial crisis ("GFC").

Our offshore asset allocation played an important diversification role relative to domestic assets. Even our recent allocation to China A equities added value to the Fund because these shares did not fall as much as the developed markets ("DM offshore") or the global emerging markets ("GEM") equities.

Investments in long-dated Real Assets that have contractual cash flows play an important role in times of market crisis and help match the liability movements of the Fund.

The marked-to-market (a method of measuring the fair value of accounts that can fluctuate over time, such as assets and liabilities) funding ratio is 133% as of 23 March 2020, indicates that the Fund is still in a financially healthy position (a fully funded status)The Fund remains vigilant and monitors the marked-to-market funding ratio regularly using its risk system. Our members should take comfort in the knowledge that the promises made to them in terms of their pensions have not been compromised by the COVID-19 pandemic.

THE IMPACT OF THE SOVEREIGN CREDIT DOWNGRADE

The news of the credit rating downgrade came on the first night of the 21-day national lockdown in South Africa (27 March) i. Although widely expected, the timing of this downgrade coincided with one of the most catastrophic and swiftest global market crashes in history, which wiped 30% off the value of riskier assets in just 25 days. By comparison, it took about 166 days to drop to the same level during the 2008 global financial crisis. South African nominal bonds and inflation-linked bonds suffered a 10% and 8% decline, respectively, as a consequence of COVD-19. Nevertheless, the EPPF's marked-to-market funding ratio remained strong and positive.

NO IMMEDIATE IMPACT OF THE DOWNGRADE ON BOND MARKET

A few days prior to the downgrade by Moody's, FTSE - who are the custodians of the World Government Bond Index (WGBI) - announced that they would postpone the March month-end rebalance for their fixed income indices (including the WGBI) and resume rebalancing as usual at the month-end of April 2020. They further stated that any index composition changes due to ratings upgrades or downgrades would not be reflected in the April index.

IMPACT OF THE DOWNGRADE ON THE FUND'S ASSETS

The value of the Fund at the close of business on 26 March 2020, before the country went into lockdown was R124 billion, having recovered from the lows of R114 billion a few days earlier. However, about 20% of the Fund (14% Inflation-Linked Bonds and 6% Nominal Bonds) is exposed to fixed income securities with no more than 4% exposed to the Listed Property sector. Hence, the impact of the credit downgrade on the assets of the Fund WAS NOT as severe as the COVID-19 market crash. In fact, the credit downgrade did not have any material impact on the Fund as it was already been priced in by the market. .

THE FUND WILL COVER ITS LIABILITIES

The EPPF is a defined benefit pension fund. Put simply, this means member benefits are not dependent on short-term investment performance but are determined by the rules of the Fund. Pension increases, on the other hand, are completely dependent on investment returns - which is a challenge in the current depressed economic environment.

CONCLUSION

The recent plunge in asset prices also presents buying opportunities for savvy investors. We continue to assess the investment opportunities that this massive fall in asset prices has presented. The Fund has a sound investment strategy for allocating assets while maintaining appropriate levels of risk and with an eye to a long-term horizon for pension liabilities and investments.

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