BY ERIC VANRAES & PASCAL PERRONE
In July, the markets were still very nervous due to the Greek crisis. Fears of Grexit and a Greek default led to many uncertainties and increased volatility. In addition, once Greece and its creditors found a solution to avoid the worst case scenario, Chinese equity markets started to decrease substantially.
Immediately questions and doubts about the pace of the Chinese growth arose again. In the US, economic statistics were dominated by the publication of the GDP figures for Q2 (annualised) at +2.3% and the final revision of the GDP figures for Q1 2015 at +0.6% against -0.2% (and -0.7%, first estimation). The non-farm payrolls number (+223k) was in line with expectations and the unemployment rate decreased from 5.5% to 5.3%. Inflation remained low, with a CPI (ex-food and energy) of +0.2%. The Federal Reserve (Fed) kept its monetary policy unchanged and the expectations of a first rate hike are expected in September by the most optimistic analysts and in early 2016 for those who believe that the Fed should postpone the normalisation of its monetary policy due to international issues. Ms Yellen said that the Fed is likely to raise its interest rate this year but the timing of lift-off is less important that the subsequent pace of increases which would be gradual. She added that the Fed monetary policy will probably remain highly accommodative for quite some time.
In Europe, the discussions between Mr Tsipras (Greek PM) and European governments (mostly Germany and France), the ECB and the European Commission relegated all the other topics, such as economic statistics to the second level. In this nervous context, one major event has almost passed without comment: on 2 July , the ECB extended its QE list to 13 new names called PSPP (Public Sector Purchasing Program). These names are corporate issuers partially (or totally) State-owned, such as the Italian Enel. They belong essentially to three main sectors: transportation, utilities, oil and gas. The Investment Adviser believes that this is the first step to the publication of a larger buy-list including other Government-related issuers and if needed, a possible further step to high quality corporate issuers (AA-A rated).
Given this uncertain backdrop, with encouraging US economic statistics offset by international issues (Greece, China…), the US Treasury yield curve experienced a bullish flattening this month: if the 2y yield climbed slightly from 0.64% to 0.66% (+2 bps), the 5y yield decreased from 1.65% to 1.53% (-12 bps), the 10y from 2.35% to 2.18% (-17 bps) and the 30y from 3.12% to 2.91% (-21 bps). Consequently, the spread 30-5y came from 147 to 138 bps. On the credit side, corporate spreads behaved differently on both sides of the Atlantic: if the US corporate CDX index did not really move, from 70 to 71 bps, the European iTraxx Main tightened from 76 to 62 bps as a consequence of the decline of risk aversion once the Greek worst case scenario has been avoided.
In July, the Investment Adviser was more attentive to the correlation between the behaviour of the Fund and the stock markets, (through its investments in corporate spreads) in order to assign to the Fund (more so than previously) the role of a natural hedge against US equities. US Treasury 2045 were added as duration (above 5) and a substantial exposure to 30y treasuries (above 10% of the portfolio but above 35% of the duration risk) which proved the most efficient investment in line with this strategy. At month end, the Fund held 48 issues from 40 different issuers.
The duration overlay policy has been active this month due to the Greek crisis. In this environment, the Investment Adviser increased the modified duration of the Fund from 4.8 to 5.5 once fears of Grexit and Greek default decreased substantially.
The Investment Adviser believes that the Fed will remain very accommodative and that Ms Yellen will continue to comment on the future behaviour of the Fed, as previous, during recent months: that the first rate hike will occur before the end of the year but expects the pace of rate hikes will be very slow and that the US Central Bank will remain ultra-accommodative. In this context, the Investment Adviser will continue to favour a flattening of the 5-30y slope of the curve with a target of 100 bps (138 bps at month end). The Investment Adviser will continue to be very cautious in picking corporate bonds and will focus on high-quality liquid issuers, as liquidity is becoming a cause for concern. Depending on the development of the markets, the Investment Adviser may maintain the duration risk of the Fund between 5 and 6. European peripheral corporate spreads denominated in USD will not be considered as a buying opportunity but investments in Italian and Spanish PSPP issuers (such as Enel or ICO) could be considered even if the ECB made it clear that the PSPP will only include bonds denominated in EUR.
The fund management team will pursue this strategy (based on lower credit risk offset by above-average duration risk) during the following weeks and still believes that positive returns will be achievable as a result of the carry of 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 Advisers to the Fund as of 14/08/15 and are based on internal research and modelling.