Cape Town – In a communique sent to its investors on Tuesday evening, Coronation Fund Managers called the last week in which it lost the value of its entire position in African Bank (Abil) “a humbling experience”. It admitted that its investment in the unsecured lender was a mistake, but attempted to reassure investors that the loss that has been suffered is not material in context of its broader portfolios.
Coronation has been criticised not only for its investment, but for what many perceived to be an attempt to disguise just how significant its holding was. Its only prior communication with investors was a note detailing the exposure of its funds on 6 August, which was after the share price had already suffered a severe decline.
It has now moved to correct this by providing detail on exactly how exposed it was to Abil equity on 5 August, the day before the trading update that sparked the sell off. It pointed out that while it was a significant investor in Abil equity, it held almost no Abil debt.
Its equity holdings are detailed in the below table:
Click image to enlarge
Performance information as per Morningstar, 12 August 2014. Competitor median and quartile rank reflect the relative performance of the various funds against their formal ASISA peer groups.Source: Coronation Fund Managers
In the communique, which is signed by chief investment officer Karl Leinberger and senior portfolio manager Neville Chester, Coronation also provided an explanation for its decision to invest in Abil over the last year. It noted that it had held a negative view of the unsecured lending market for many years prior to 2013 and had stated this publicly.
“This was based on a combination of aggressive credit extension, increased competition and a lengthening of loan term that had created a credit bubble,” it said. “Until the second half of 2013 our client portfolios had virtually no exposure to any microlender, be it through equity, debt or money market instruments.”
It was around this time that the unsecured market began to feel the impact of the credit bubble that had been created primarily through irresponsible lending practices. Many non-performing loans had to be written off and the supply of credit was cut back across the industry.
“In August 2013, African Bank released a disappointing trading update and announced a very dilutive rights issue,” Coronation explained. “It was largely around this time that we built our position.”
At this point Coronation took the view that Abil’s track record and the fact that it had survived the last major crisis in the sector in the early 2000s made it likely that it would also emerge from this downturn in a dominant position.
“In the lead up to the rights issue in the fourth quarter of 2013, the share price halved from its peak in early 2012,” Coronation stated. “Management made a compelling argument that the rights issue created the opportunity to provide fully against their bad loans and put their mistakes behind them.”
Coronation also took the view that enough time had passed for the bad loans from the last cycle to surface. In addition, it was encouraged by the fact that Abil was able to raise more money in the rights issue than the market expected.
“We concluded that painful lessons had been learnt by the management team and that the business was now well placed to survive the downturn,” it noted. “Coronation supported the rights issue, using it to build a meaningful stake in the bank.”
The communique explains that Coronation’s due diligence showed that while Abil had written poor credit in the boom years, it was no longer doing so. Its analysis of the books at other lenders also gave the impression that the market had bottomed.
However, this turned out to be a misjudgement.
“In the fullness of time we were proved wrong,” Coronation admits. “As outsiders we do not yet know why the book performed so much worse than the representations made by management portrayed. For the answer to this question, we will have to wait.”
Coronation also pointed out that only its funds with higher risk profiles were exposed to Abil. Its more defensive funds did not hold any Abil shares.
It further noted that although the number of Abil shares it held was significant, the relative size of the positions in its portfolios was not. For this reason it argues that the company’s failure has not had an undue impact on fund performance.
Coronation’s exposure to Abil was also almost exclusively through equity. It avoided debt, preference share and money market exposure.
“Although we understood that there were risks, we believed that there was significant upside in the equity,” Coronation explained. “We did not feel that other instruments in the capital structure offered this payoff profile, hence our strong preference for the equity.”
It contended that while there has been greater focus on the losses suffered by equity investors, the aggregate rand losses in these other instruments will ultimately be comparable.
“Fund exposures to these instruments are not as transparent as equity exposure, and have therefore not been as extensively covered by the media in its reporting of the bank’s collapse,” Coronation said.
The fund manager also indicated that it was able to sell a large portion of its Abil holding in the aftermath of the trading update, and had reduced its position to less than 9% of shares in issue at the market close on Friday 8 August.
“Losses have been incurred, for which we apologise,” the communique concluded. “This has been a humbling experience for us. We do not like to make mistakes. Unfortunately mistakes are part of life for an investment manager. The challenge is to make sure they aren’t material and that we learn from them.”