In what appears to be an unprecedented episode in the South African unit trust industry, investors in the Third Circle MET Target Return Fund lost 66% of their investment in just two days last month. The fund’s net asset value fell from 98 cents per unit at the close of trade on Thursday 10 December to 33 cents per unit by the close on Monday 14 December.
In total, investors lost more than R250 million in this two-day period. Third Circle also runs two other unit trusts, both of which are heavily exposed to its Target Return Fund and so suffered knock-on effects. The total capital loss between the three funds is estimated to be just short of R435 million:
Moneyweb has established that the losses in the Target Return Fund were caused by the fund managers taking extensive derivative positions that they were unable to unwind in their favour when the market moved. The fund held options in shares such as FirstRand, Barclays Africa, Nedbank, Sanlam, Remgro and Woolworths, which were all impacted by the market sell-off.
A number of people within the industry have expressed their disbelief at the severity of the capital losses. Questions have also been raised about the risk governance employed by Third Circle as the asset manager, the administrator Metropolitan Collective Investments, and the trustee Standard Bank.
The events in December
These huge losses took place in the bout of market volatility that was triggered by the removal of Nhlanhla Nene from the Finance Ministry on December 9. The fund’s performance was however way out of step with the overall market.
The value of the Third Circle MET Target Return Fund fell 35.14% on the Friday and a further 47.46% on the Monday. By contrast, the JSE All Share Index was down just under 2% on the first day, and flat on the second.
Third Circle’s head portfolio manager Ian Lane, told Moneyweb that this fund uses options to gain exposure to local equity as the managers believed it provided downside protection, even though it meant that they didn’t get the full upside.
However, in the sharp market weakness following Nene’s dismissal, these positions became massively problematic. The hedge that Third Circle believed it had in place through options on the Top 40 also did not provide the protection they anticipated it would.
The fund managers were thus forced to “rapidly neutralise positions on the morning of December 11, in order to both maintain compliance with the Collective Investment Schemes Control Act (CISCA) and to avoid deepening capital losses in the best interests of our investors,” Lane explained. “As invariably seems to always befit a perfect storm, this was also the absolute bottom of the market. The correction and consequent market bounce transpired on Monday December 14, however the loss making positions were already realised and the fund was thus unable to fully participate in the rebound.”
Fund reporting and governance standards
Compounding the issue of the fund performance is that the extent of the derivative positions in the fund was not disclosed on its fact sheet. According to the minimum disclosure document (MDD) produced by Third Circle and Metropolitan Collective Investments at the end of November, the fund held 96.14% of its assets in cash or money market instruments.
Lane said that this is “technically correct”, however it includes amounts in a settlement account and the JSE/Safex margin account. These would be its derivative positions. Third Circle even produced and published on its website an MDD for the end of December showing an asset allocation of 97.89% to cash and the money market.
When this was queried by Moneyweb, however, Third Circle came up with a new document that reflected only 43.47% in cash, and derivative exposure of 43.42%. Strangely, the second fact sheet also showed foreign equity exposure of over 10%, which is not mentioned in the first fact sheet or in the fund’s detailed portfolio for the end of December.
The CEO of Metropolitan Collective Investments, Mickey Gambale, told Moneyweb that neither of these fact sheets were approved by them as administrators and they are now querying why Third Circle produced them.
He added that they are conducting a thorough analysis of the portfolio to look at exactly what happened in December. They are looking at how each option behaved and where mistakes might have been made.
“MetCI immediately started an investigation on the large market movement on this portfolio to ascertain the exact root cause,” Gambale said. “We are currently in the process of identifying the instruments within the portfolio attributable to the performance loss in order to get a complete and full understanding of the events which caused it. Currently our investigations are still under way and we are in discussions with the portfolio manager, our trustees, and our own internal risk and compliance teams.”
He however added that he does not believe that the fund’s portfolio was in contravention of CISCA guidelines.
This is a view that appears to be shared by the Financial Services Board (FSB). Jurgen Boyd, the deputy executive offer for Collective Investment Schemes at the FSB, told Moneyweb that they currently do not see a need to investigate.
“From our perspective, based on the information as at December 31, 2015, notwithstanding the losses, the manager continues to comply with investment policy,” he said. “As with other types of investments, the investor takes investment risk and the registrar does not interfere nor investigate investment losses in relation to the level of risk of an investment.”
Moneyweb also approached Standard Bank for comment, but the bank declined to add anything to what Metropolitan Collective Investments had already told us. It did however confirm that it was working with the administrator on the matter.