PRESCIENT INVESTMENT MANAGEMENT

INVESTING IN MUNICIPALITIES
INVESTING IN MUNICIPALITIES

Prescient is a quantitative investment manager aiming to deliver risk-adjusted returns for its clients over the
long-term. The quantitative investment approach is governed by the primacy of capital preservation and the
management of downside risk.

CREDIT PROCESS
A high degree of emphasis is placed on credit risk management where we evaluate the credit quality and
worthiness of all credit instruments. Our credit research encompasses a four tiered process:

1. Distance-to-Default
2. Momentum Indicator
3. Ratio analysis
4. In-house sentiment Indicator/Credit Rating

We combine these four measures of credit risk into one score by weighting them according to the importance
we place on each measure. Only issuers with appropriate credit scores will be considered for investment.

GOVERNANCE POLICY - GENERAL

To complement our more quantitative approach to credit risk assessment we have designed a governance
polity that helps us assess all companies, including state-owned enterprises and municipalities in greater
details. When we assess governance conduct, we may consider the following key areas:

 The tone at the top/ ethical conduct;

 The composition and operations of the board;
 The composition and operations of board committees (e.g. audit committee, risk committee, social and
ethics committee);
 Whether there are active control functions (e.g. compliance, internal audit, enterprise risk management);
 Who performs the external audit and the nature of the external audit opinion and findings;
 How the entity delegates authority and responsibility;
 The soundness and clarity of the strategy, and whether performance is measured and linked to
remuneration.

Governance Policy – State-Owned Enterprises (SOE) and Municipalities (MUNI)

SOE’s and MUNI’s are governed by legislation enabling the necessary disclosures for reporting governance
related issues.

SOE’s are subject to the Public Finance and Management Act. MUNI’s are subject to the Municipal Finance
and Management Act, both of the acts overseen by National Treasury.
Each SOE, as well as each MUNI, are required to report to National Treasury in terms legislation. Each Act
requires (at a minimum) disclosure on key governance areas as follows in the Annual Financial Statements:

1. Compliance with legislation

2. Corporate Management
3. Internal Control
4. Financial Misconduct
5. Expenditure Management

The Annual Financial Statements of a SOE or a MUNI are required to be prepared in line with IFRS and are
required to be audited by Auditor General of South Africa (AGSA). AGSA may outsource the audit function.

Prescient assesses the audit opinion as a key to credit risk management (and the implementation of the ratio
analysis) as well as the ability to rely on the accuracy of reported numbers. The auditors are required to express
an opinion on the financial statements based on their audit in accordance with the international standards of
Auditing. We assess the following information during our due diligence process:

 Disclosure in the Annual Financial Statements;

 Municipalities disclose via an on-line portal;
 Annual internal questionnaires are sent to SOE’s and MUNI’s;
 Audit opinion is considered;
 Compliance with legislation;
 Internal control deficiencies;
 Any investigations on going;
 Quantum of fruitless and wasteful expenditure.

Investment Implications

We have invested and will continue to do so in some SOEs where issues of governance are taken seriously
and where the investment cases makes sense for our clients.

Our reluctance so far to invest in municipalities is driven by a combination of the factors illustrated above. In
general, municipalities have less historical data needed to perform any sound quantitative analysis. Their bond
issuances are generally small in size, less liquid and in most cases are not listed or rated. Issues of governance
further complicate matters as most municipalities have had many findings in their annual reports by the various
auditors. Until issues of liquidity and governance are addressed in a decisive way it will remain a challenge to
invest with municipalities in South Africa.

d support of the Code.