Fitch Affirms Ceylon Dollar Bond Fund at ‘BB-’/’V-5’

Fitch Ratings has affirmed Ceylon Dollar Bond Fund’s Fund Credit Quality Rating of ‘BB-’. The Fund Volatility Rating is ‘V-5’. The fund only invests in US dollar-denominated bonds issued by the Sri Lankan sovereign, licensed banks and corporate issuers. The fund is managed by Ceylon Asset Management (CAM). 

Key rating drivers

The ‘BB-’ Fund Credit Rating is driven by the weighted average rating factor (WARF) and rating distribution based on the expected composition of the fund and the fund’s investment guidelines. The rating also reflects the fund’s total assets which are currently placed in US dollar deposits at a local licensed commercial bank. The fund has limited investment space as it will only invest in US dollar bonds issued by the government of Sri Lanka, licensed banks in Sri Lanka and Sri Lankan corporates that are rated by an international rating agency. This limits the current investment space to 11 issuances totalling just over USD7bn. The manager expects the allowable investor base to increase within the next three months, which would help the fund to attract significant investments.

Asset credit quality

The fund’s target portfolio comprises bonds rated ‘BB-’ or lower issued by the entities detailed above. The fund will invest up to 10% of its assets in US dollar fixed deposits in a licensed commercial bank in Sri Lanka. It is currently invested only in bank deposits with Deutsche Bank Sri Lanka, a branch of Deutsche Bank AG (A+/Negative/F1+).

Concentration

As a result of the limited investment opportunities, Fitch expects the fund to be moderately concentrated. Consistent with the agency’s rating criteria, Fitch has therefore conducted stress tests on the expected portfolio. Based on its analysis, Fitch believes the fund has a limited capacity to withstand negative rating migration in its investments before it would be downgraded to the ‘B’ category. 

Liquidity

The fund will invest in instruments with a relatively long maturity (WAL of 2.75 years in the target portfolio) except for an allocation of up to 10% to three-month deposits. Therefore the fund will be reliant on secondary market liquidity to meet large redemption requests. However, the fund has access to an overdraft facility of 10%, and requires 14 days’ notice on redemptions above 3% of the fund. On the asset side, it will hold only a limited proportion of outstanding debt issues, all of which will be listed on the Singapore Exchange.

Portfolio sensitivity to market risk

The Volatility Rating of ‘V-5’ reflects the target portfolio’s relatively long WAL and a market risk factor (MRF) of 8.5. Fitch’s calculation of the fund’s MRF incorporates a weighting to take into account the volatility expected in lower-rated emerging market debt. According to Fitch’s criteria, funds rated ‘V-5’ are considered to have high sensitivity to market risk. On a relative basis, total returns and/or changes in net asset value are expected to experience substantial variability across a range of market scenarios due to substantial exposure to interest rates, credit spreads and other risk factors. 

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.

The advisor

Fitch considers CAM suitably qualified, competent and capable of managing the fund. The investment committee has relevant 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 to be satisfactory. 

CAM is 21%-owned by Sri Lanka Insurance Corporation Limited (SLIC, AA(lka)/Stable), 69% by Ceylon Capital Trust Ltd. and 10% by Commercial Credit and Finance Plc (CCF). Fitch believes it has support from the shareholders. However, a key challenge facing the business will be to demonstrate sustained growth in assets under management. The Ceylon Dollar Bond Fund is a key component of its growth strategy. CAM has been in existence and managing funds since 1999. The current management team has been in place since 2005, and SLIC and CCF invested in the business in 2010 and 2013, respectively.

Rating sensitivities 

The ratings may be sensitive to material changes in the credit quality or market risk profile of the fund. A weakening in the liquidity inherent in the fund or changes to liquidity provisions - such as the manager’s ability to borrow against the net assets of the fund or its ability to delay redemptions - would be viewed as negative. 

A downgrade of the ratings of the banks where the fund has currently invested its assets could also lead to a downgrade of the fund. Changes in exchange-control regulations that could affect the fund - leading to transfer and convertibility risks - would also be viewed as negative.

Fitch will review the fund after six months to see if the fund has achieved an appropriate level of diversification, consistent with its target portfolio and investment guidelines as indicated by the manager. If the fund fails to gain a considerable size within this period, Fitch will withdraw the rating as it would no longer be relevant to Fitch’s coverage.

Fitch has capped the fund’s rating at that of the Sri Lanka sovereign (BB-/Stable), given its expected material exposure to Sri Lankan sovereign bonds. Therefore upside potential for the fund rating is limited.

To maintain the bond fund ratings, CAM will provide Fitch with portfolio information, including details of the portfolio’s holdings and credit quality. Fitch closely monitors the credit composition of the portfolio, the credit counterparties used by the manager, and the overall market risk profile of the investments.