Growth concerns push yields lower

During December, the main financial markets were driven by Brexit uncertainties, the pause in the trade war between the US and China, the last Fed rate hike of the year and the continuing social troubles in France. The month started with a mitigated set of employment data in the US with only 155’000 jobs created while average hourly earnings stabilised at +3.1%.

Monthly Fund Commentary
4 Feb 2019

During December, the main financial markets were driven by Brexit uncertainties, the pause in the trade war between the US and China, the last Fed rate hike of the year and the continuing social troubles in France. The month started with a mitigated set of employment data in the US with only 155’000 jobs created while average hourly earnings stabilised at +3.1%.

In Europe, the fears of slowdown increased in France and Italy. In Germany, a possible recession can not be ruled out as exports decreased sharply. Government bonds rallied, the US curve started to invert (2-5y) and corporate spreads widened on both sides of the Atlantic. Emerging bond spreads stabilised as many investors bet on Emerging Markets (both equities and bonds) as a top performing asset class in 2019. During this last month of 2018, fears of a global slowdown increased sharply: first and foremost in China, then in the US and Europe. This month also marked the end of the ECB’s asset purchase program.

STRATEGIC EURO BOND FUND
STRATEGIC GLOBAL BOND FUND
STRATEGIC QUALITY EMERGING BOND FUND

The three bond Funds were liquidated on 14th December and the Investment Adviser has continued to sell the issues that could not be transferred into the new Fund, mainly bonds denominated in euro with very low yields and emerging market bonds in US dollar which do not align with the new investment strategy.

STRATEGIC BOND OPPORTUNITIES FUND

The new Fund was successfully launched on 14th December with an AUM slightly below USD 60 million. The Investment Adviser adjusted the allocation slightly, between Treasuries, Investment Grade and Emerging Markets but postponed most of the strategic moves until January, when liquidity returns to the fixed-income markets. The Strategic Bond Opportunities Fund’s strategy is the “best of” the three former funds, the core portfolio being the former Strategic Global Bond Fund. In addition, select Emerging Market bonds (around 30%) have been added to the portfolio, a number of which were previously held by the Strategic Quality Emerging Bond Fund. Further, a small number of bonds denominated in euro, previously held by the Strategic Euro Bond Fund (around 16%, hedged into US dollar) have also been included in the new Fund’s portfolio.

OUTLOOK

The Investment Adviser’s outlook is focusing on two major topics: inflation and the Central Banks’ stand-point. The risk of inflation remaining subdued and the US yield curve flattening, combined with other topics such as the risk of the trade war escalating, suggest that recession fears (or at least fears of a significant slowdown) will rapidly become a major concern. In addition, after the recent correction of emerging markets and the European periphery, the team is still convinced that high quality bonds, considered as safe havens, will attract more investors in the coming months.

In the US, the Investment Adviser believes that long US Treasuries are still attractive and that they could be a top performing asset class in 2019. An inverted curve slope can not be ruled out for early 2019, after the Fed rate hike on 19th December. The Fed may be making a mistake by pursuing its monetary policy normalisation, the markets not having the capacity to absorb any additional rate hikes. The Investment Adviser believes that the best strategy today is to keep investing in short term corporate bonds yielding around 3.5% combined with 30y US Treasuries. The behavior of the Fed will be a key driver of the markets and bond yields will also depend on the evolution of equity markets. The Investment Adviser believes that only one more rate hike in the US will be possible in 2019 and that the Fed will probably be forced to ease before year end. Consequently, the Fed funds rate could be back to their current level in one year.

In Europe, the Investment Adviser believes that the Bund will match the US Treasuries behavior and will also perform well in case of any resurgence of tension in Italy or France and in the case of recession fears in Germany. Brexit uncertainties will also add stress to the market. A QE2 is possible in the Eurozone before the end of 2019.

In the Emerging Markets, the Investment Adviser continues to closely monitor the behavior of spreads (both governments and corporates) and the increasing volatility due to global risk aversion. Spreads have widened substantially in 2018 and some Emerging bonds could perform well in 2019.

In conclusion, the Investment Adviser etains the belief that the best performing asset class will be a mix of short term Investment Grade corporates and long-dated US Treasuries. Emerging markets re likely to remain volatile during the coming months, but current levels offer an attractive opportunity to invest in very high-quality EM markets. Bonds denominated in euro and hedged in US dollar are also becoming an attractive investment opportunity.

The views and statements contained herein are those of the Eric Sturdza Banking Group in their capacity as Investment Advisers to the Fund as of 11/01/19 and are based on internal research and modelling.