PSPP + CSPP = APP

BY ERIC VANRAES

Monthly Fund Commentary
18 Apr 2016

BY ERIC VANRAES

In March, the major driver of the behaviour of financial markets was, by far, the ECB’s meeting on 10th March. In the global bond market, concerns about a possible Brexit,  the US Presidential election and political turmoil in Brazil had a less pronounced impact.  However, the strong rebound of oil prices, from $33.70 to $38.30 helped the recovery of risky asset markets to the detriment of safe havens.

In Europe, good PMI indices showed  that the Eurozone economy is growing but soft inflation and weak output prices led to  greater deflationary fears. In the US, economic data continued to send contradictory  signals: the ISM figures were strong but durable goods orders were disappointing and  some unemployment data were negative. Regarding Central banks activity, the ECB did  not miss its target with an expanded QE (EUR 80 billion / month instead of 60) which will  be open to corporate bond purchases, a deposit rate decreased to -0.4% (from -0.3%) and  a new TLTRO, which is probably the  least commented about measure but  the most important. The expanded  APP (Asset Purchase Program)  will add private corporate bonds  (CSPP, Corporate Sector Purchase  Program) to government-owned  corporates (known as PSPP, Public  Sector Purchase Program) towards  the end of Q2. The amount of QE now reaches 20% of Eurozone GDP.  In the US, Mrs Yellen said that the  Fed should “proceed cautiously”.  The US Central bankers are probably still in a “wait and see” mode: they are convinced  that the pace of the domestic economy deserves a rate hike, but they have difficulty  analysing the potential impact of weaker global growth (first and foremost in China) on  the behaviour of the US economy.

In this context, the German yield curve experienced a bearish flattening, the 2y yield  increasing from -0.57% to -0.49% (+8 bps), the 5y yield from -0.41% to -0.33% (+8 bps)  and the 10y Bund yield from 0.11% to 0.15% (+4 bps) as investors appetite for CSPP  bonds increased dramatically. Consequently, on the credit side, the European iTraxx  Main tightened substantially from 99 to 73 bps (-26 bps) while the US corporate CDX  index rallied from 107 to 79 bps (-28 bps) led by the behaviour of European corporate  spreads and the rally of the energy sector after the strong rebound of oil prices.

In March, following the strategy which was implemented in June 2015, the Investment  Adviser continued to favour high quality and liquidity. He bought two government owned  corporate bonds that have a high probability of being included in the ECB’s new  APP: Proximus (ex-Belgacom), the Belgian telecom operator, and Fortum, the Finnish  utility company. The remaining stake in Deutsche Bahn was also sold, and profits were  taken on US issuers by selling Oracle and decreasing the weight of IBM.

The Modified Duration of the Fund stayed above 2 (around 2.3) and the duration overlay  policy has not been modified. In terms of portfolio diversification, the Fund held 44  issues from 40 different issuers.

The Investment Adviser believes that the ECB will stay ultra-accommodative in the  coming months even if Mr Draghi already “did the job” at the ECB meeting in March.  The economic conditions are not particularly improving in the Eurozone with weak growth and, more importantly (as it is the unique mandate of the ECB) low inflation. Regarding  the Fed’s policy, the behaviour of the FOMC in 2016 is still unclear: inflation is low but will  increase gradually (due to the base effect after the sharp decrease  of oil prices in 2015), oil prices seem to have stabilised around $40  a barrel and international issues are unclear (China in particular  raises two questions, the exact situation of the economy and the  probability of a Renminbi devaluation). The Fed is still expecting  more rate hikes than the market.

The Investment Adviser is still extremely cautious on corporate  spreads and on liquidity of the credit market. He will continue  to focus his investments on those included in the APP (i.e. the  PSPP and CSPP). High beta names will be avoided except very  short maturities with a “buy and hold until maturity” strategy. The  modified duration of the Fund may be maintained around 2.5. The  Investment Adviser will pursue this strategy during the coming  weeks and still believes that positive returns will be achievable  as a result of the carry of APP bonds and high-quality corporates,  their spread tightening potential, credit selection and active  management of duration and yield curve.

The views and statements contained herein are those of Sturdza Private Banking Group in their capacity as Investment Adviser to the Fund as of 15/04/16