Strong Credit rally supported by an expected increase of ECB’s stimulus and extension of BoE’s QE programme to corporates


Monthly Fund Commentary
17 Aug 2016


In July, risky assets recovered strongly as the slowdown due to Brexit did not materialize. In line with equity markets, low quality debt such as high yield and deeply subordinated debt rebounded following their post-Brexit sharp correction.

In this context, IG Corporates, US Treasuries and Bunds performed well. In the US, 287,000 jobs were added in June, easing concerns after last month’s poor number. Globally, US Data was better than expected with housing momentum and confidence continuing to point up. As a result, market participants eliminated the probability of a Fed rate cut in December and started to price in a possible rate hike (up to 35%) before the end of the year. In Europe, as expected, the ECB left monetary policy unchanged but remained ready to increase stimulus should economic forecasts dramatically change following the UK referendum. Any expansion of the current Asset Purchase Programme (APP) will need changes to the bond eligibility rules given the ultra-low yield environment. The BoE didn’t cut rates but offered additional liquidity operations and reduced capital requirements. Next month’s growth and inflation forecasts revisions may force the BoE to implement an easing package.

In this context, the German yield curve experienced a bearish flattening, the 2y yield increasing from -0.66% to -0.63% (+3bps), the 5y yield from -0.57% to -0.53% (+4bps) and the 10y Bund yield from -0.13% to -0.12% (+1bps). At the same time, Italian and Spanish 10y yields decreased from 1.26% to 1.17% (-9bps) and from 1.16% to 1.02% (-12bp) respectively, reducing their spreads against the German 10y yield. At month end, European Banks stress tests conducted by the ECB with the assistance of the EBA showed an overall solvency improvement since 2014. There were no major surprises, with the exception of Monte dei Paschi (MPS), which presented its bailout plan immediately after the tests results.

In the US, the 2y US Treasury yield increased from 0.58% to 0.66% (+8bps), the 5y yield from 1.00% to 1.02% (+2bps), while the 10y decreased from 1.47% to 1.45% (-2bps) and the 30y long bond yield fell from 2.28% to 2.18% (-10bps). On the credit side, the European iTraxx Main tightened from 85 bps to 68 bps (due to the rebound of cyclicals, industrials and financials following Brexit fears) while the US corporate CDX index tightened from 77 bps to 72 bps. In Emerging Markets, the CDX 10y EM index spread remained relatively stable at 295 (+3bps).

In Emerging markets, the major event was the Turkish coup attempt which tempered the positive market momentum. Turkish assets suffered during the week following increased volatility and higher political uncertainty, before stabilizing on Turkish officials’ declarations and central bank intervention to restore confidence.


During the month, the Investment Adviser continued to favour high quality and liquidity. With yields having reached new lows post-Brexit, he took profit on most of the Finnish Government 2020 exposure and decreased the weight of Wuerth 2018, Nederlandse Watershapsbank 2019, Tennet 2020, Enexis 2020 and Nederlandse Gasunie 2022. Finally, he maintained the duration at 2.1 in the current low yield environment. In terms of portfolio diversification, the Fund held 41 issues from 39 different issuers.


Similar to the Euro Bond Fund, the Investment Adviser did not change the global strategy implemented in June 2015, favouring high quality and liquidity. He added new positions in LVMH 2017, McDonald 2018, Pepsico 2019, Orange 2019, Hyundai Capital America 2020. The modified duration of the Fund was increased from around 4.6 to 4.9 by buying additional 30yr Treasuries on a yield retracement level of 2.35%. In terms of portfolio diversification, the Fund held 35 issues from 31 different issuers.


In July, the Investment Adviser switched out of Bndes 2020 and Croatia 2021 on downgrade risks. Post the Turkish coup attempt, he sold the entire exposure to Export Credit Bank of Turkey, Turkiye Garanti Bankasi 2022 and reduced the weight of Anadolou Efes 2022 and Turkcell 2025. Proceeds and inflows were mostly invested in A-BBB issuers with the objective of reducing spread volatility and lowering the risk profile by adding: Development Bank of Kazakhstan 2022, State Oil of the Azerbaijan 2023, Hungarian Development Bank 2020, Poland 2026, Export-Import Bank of India 2023, Romania 2024, Azerbaijan 2024, Namibia 25 vs Namibia 21, China Development Bank 2026, Lithuania 2020, MMC Norilsk Nickel 2022. In terms of geographical breakdown, the top 3 countries were Russia (16.9%), Brazil (7%) and Hungary (6.3%). The top 3 sectors were Government (40.7%), Energy (16.5%) and Basic Materials (12.6%). The rating allocation was 44.9% BB, 35.9% BBB, 3.8% A and 7.4% AA (and 8% cash). The modified duration reached 6.04 at month end. In terms of portfolio diversification, the Fund held 35 issues from 34 different issuers.


Despite little evidence of a material impact on sentiment, production and consumption in the Eurozone caused by Brexit, the Investment Adviser believes that the ECB will stay ultraaccommodative in the coming quarters. Indeed, there are substantial disparities between European countries and the outlook doesn’t point towards any strong economic growth rebound in the coming quarters. The economic conditions are slightly improving in the Eurozone but not enough for companies to increase investment and wages. In this environment, the risk is that households will continue to hoard cash and spend less given increased uncertainties. If necessary, Mr Draghi will not hesitate to implement new measures against the risk of deflation by either cutting rates or expanding its QE balance sheet. At the same time, the BoE may decide to implement similar non-conventional measures by starting to buy corporate bonds, similar to the ECB’s Corporate Sector Purchase Program (CSPP). Regarding the US, the Fed has an opportunity to raise rates at its September FOMC meeting before the November presidential election. However, concerns about consumer spending sustainability, the persistent weakness of inflation and recent international issues (Brexit consequences, China growth momentum) may delay any rate increase. The Investment Adviser still believes that there will be no more than one rate hike this year, if any, and that the probability of a rate cut will increase gradually at the end of the year (simultaneously with the probability of a recession in 2017). He will stay overweight 30y US bonds (both Treasuries and TIPS) and will seize any opportunity to buy dips in order to increase the modified duration of the Strategic Global Bond Fund from 4.9 to around 6. Emerging Markets will stay volatile but technical factors (positive inflows, low net issuance) combined with the negative or low yield environment in most developed markets, higher commodity and oil prices, the stabilisation of emerging currencies and a “wait-and-see” Fed, suggest that the environment will remain supportive for further spread tightening. A sustained rally post-Brexit would probably lead to a more cautious approach, reducing the risk profile by maintaining higher exposure to A-BBB vs BB rated issuers in order to lower volatility and spread-widening risks.


The views and statements contained herein are those of the Eric Sturdza Private Banking Group in their capacity as Investment Advisers to the Fund as of 15/08/16 and are based on internal research and modelling.