How we did in January: The fund returned between 4.4% and 4.7% across different share classes, compared to EUR HY (BAML HE00 Index) 3.2%, US HY (BAML H0A0 Index) 3.9% and EM sovereign credit (BAML EMGB Index) 3.2%. Performance in January, gross of fees in EUR, was: (i) Credit: 481bps, with 511bps from cash and -30bps from CDS; (ii) Rates: -55bps; (iii) FX: 3bps, (iv) Equity: 37bps and (v) Other: -1bps.
January was a very strong month for fixed income markets. Continued disinflation in the US lead to almost 50bp tightening in US 10y Treasuries, and credit spreads substantially tightened. Investors started deploying liquid resources accumulated in 2022, and as a result cash markets outperformed in credit. Primary markets opened again after a soft 2022, and the US dollar weakened, leading to outperformance in non-US assets.
What are we doing now: The fund continues to be long credit but conviction has been reduced in light of the recent tightening. We are marginally reducing exposure to IG names, which performed well but are now tight, and reducing net exposure via long CDS index protection.
The fund is 65% net invested in credit, with 2.1y duration and 6.5% blended YTM.
Net exposure is made of 95% cash exposure and 30% net short in CDS.
We continue to think that 2023 will be a positive year for bonds, as disinflation supports duration and a bad recession will be avoided at global level, which is positive for credit spreads.
However, this scenario is more than well priced in rates markets, where curves are deeply inverted and price cuts in 2023.
As a result, we think the market may be set for a correction short-term, so that US rates re-price cuts, credit sells off and USD gains, reverting some of the rally in early 2023.
The CDS protection recently added, together with some long US dollar positions, are meant to protect capital in this scenario. Fund duration has not been altered meaningfully as already below major credit indexes.
On the cash book, we maintain a relatively high credit quality, though we reduced some tight IG names in early 2023.
In financials, we reduced US Senior and Tier 2 and added to AT1 in Europe.
In corporates, we are reducing new issues that performed well, especially IG, and add more cyclical sectors (residential, aircraft leasing) in issuers with strong fundamentals.
In EM, we are rotating BBB into BBs in USD bonds, and overall rotating hard currency to local currency bonds in countries where central banks have room to cut.
Our net credit book exposure (excl. CDS index) is made by 51% financials, 26% corporates, 11% emerging markets.
Gross exposure in the fund is 157%. The credit short book is 42%, of which 12% in cash credit and 30% in CDS (23% index, 7% single name CDS).
Financial Credit Strategy
The new year started with a bang, led by a flood of new issuance across both financials and corporates. For context, European primary in January was just over €102bn, exceeding the combined volumes in both January and February 2022 (c.€102bn) and landing comfortably ahead of the c.€90bn seen in Q3-22. Financials alone represented around two-thirds of volumes for the month and included €5.6bn of AT1s from issuers like BNP, Banco de Sabadell, Société Générale, Crédit Agricole, Lloyds and Ibercaja. We participated in all the new AT1 deals, where books were more than 4.6x covered on average highlighting the relative attractive demand for the asset class. Going into February, we are expecting another surge of primary, especially following the announcement of FY22 results as most European financials exit the blackout period.
Looking at the broader market, risk assets rallied hard to start the year on a very solid strong footing. Global equity indices rose on average +7% driven in part by a 25bps rally across sovereign rate curves as economic data gave further credence to the notion that inflation has potentially peaked. 2s10s inverted by a similar amount in January and currently stand at historically low negative levels with markets increasingly thinking that central banks’ hiking policy is nearing an end. Within this conjecture, financials outperformed once again as higher rates directly feed into higher earnings; leading equity bank indices rose c.14% across Europe and the US, with credit spreads across the capital structure tightening by 40bps in Senior, 60bps in subordinated, and AT1s +4pts.
M&A was topical in the month ignited by a surprise headline that First Abu Dhabi Bank (FAB) was considering a bid for Standard Chartered. While the news was swiftly quashed within minutes, First Abu Dhabi Bank confirmed it did evaluate a possible offer for Standard Chartered but was no longer doing so. Since then, news reports linking FAB to Standard Chartered continue to linger with speculation that a deal could be revived upon the expiry of the mandatory 6 month restriction under the UK Takeover rules. More importantly, BNP’s sale of Bank West to BMO finally received the necessary regulatory approval and the transaction is now scheduled to close on 1 February. To recap, the sale is expected to free up c.100bps of capital with BNP set to confirm the exact financial impact during its 4Q22 results.
Amongst the first few 4Q results by leading European banks, UniCredit offered solid evidence of the positive upside from higher interest rates for European banks. Results came in significantly ahead of consensus across all key areas (c.95bps in capital and +10% in NII) which allowed management to lift its proposed distributions as well as its 2023 outlook. UniCredit shares encapsulated the strength of its 4Q22 results and closed up c.14% on the day with subordinated spreads c.20bps tighter making it one of the top performers in financials in January.
In the final window of early TLTRO repayments, European banks repaid €63bn in borrowings, far below market expectations of €213bn and down sharply from the €450bn in December. Following the repayment in January, TLTRO borrowings stand at €1.26tn, of which c.50% is set to mature by June 2023 which is when the largest tranche rolls off. For now we do not expect this repayment to have any significant impact on banks’ liquidity measures given the excess amount of deposits that exist across the European banking system and the (for now) relatively low beta of deposit repricing. This could change as the ECB remains on its hiking path and is worth close monitoring.
Financial Equity Strategy
The fund saw significant positive contributions from our positions in the US “bank tech” subset of the financial technology sector. These companies provide software and technology services to the banking industry. There are strong revenue growth tailwinds for this group as community banks and credit unions need to spend heavily on digital solutions to keep up with changing customer demand and preferences while competing with the likes of Bank of America, JPMorgan Chase, etc. The tailwinds are especially strong for smaller, more nimble players like our holdings Q2 (QTWO), nCino (NCNO), and Alkami Technology (ALKT) that can take share of a growing pie from larger, slower moving industry incumbents.
Throughout 2021 and 2022, these stocks derated dramatically amid Fed tightening, macroeconomic concerns, and contracting market multiples. Price declines of 60-80% created attractive entry points for long-term secular growth stories which also possess significant takeout potential given their valuable long-term contracts and recurring revenue streams. To that end, private equity firms have raised billions to deploy in the financial services software space over the next several years. The stocks have been strongly correlated to US monetary policy; as clarity regarding the end of the Fed hiking cycle has continued to emerge, along with increasing investor confidence in an economic soft landing, a substantial overhang has begun to recede helping the stocks recover strongly from depressed levels.
Global credit strategy
How we did in January: The fund returned between 4.4% and 4.7% across different share classes, compared to EUR HY (BAML HE00 Index) 3.2%, US HY (BAML H0A0 Index) 3.9% and EM sovereign credit (BAML EMGB Index) 3.2%. Performance in January, gross of fees in EUR, was: (i) Credit: 481bps, with 511bps from cash and -30bps from CDS; (ii) Rates: -55bps; (iii) FX: 3bps, (iv) Equity: 37bps and (v) Other: -1bps.
January was a very strong month for fixed income markets. Continued disinflation in the US lead to almost 50bp tightening in US 10y Treasuries, and credit spreads substantially tightened. Investors started deploying liquid resources accumulated in 2022, and as a result cash markets outperformed in credit. Primary markets opened again after a soft 2022, and the US dollar weakened, leading to outperformance in non-US assets.
What are we doing now: The fund continues to be long credit but conviction has been reduced in light of the recent tightening. We are marginally reducing exposure to IG names, which performed well but are now tight, and reducing net exposure via long CDS index protection.
Financial Credit Strategy
The new year started with a bang, led by a flood of new issuance across both financials and corporates. For context, European primary in January was just over €102bn, exceeding the combined volumes in both January and February 2022 (c.€102bn) and landing comfortably ahead of the c.€90bn seen in Q3-22. Financials alone represented around two-thirds of volumes for the month and included €5.6bn of AT1s from issuers like BNP, Banco de Sabadell, Société Générale, Crédit Agricole, Lloyds and Ibercaja. We participated in all the new AT1 deals, where books were more than 4.6x covered on average highlighting the relative attractive demand for the asset class. Going into February, we are expecting another surge of primary, especially following the announcement of FY22 results as most European financials exit the blackout period.
Looking at the broader market, risk assets rallied hard to start the year on a very solid strong footing. Global equity indices rose on average +7% driven in part by a 25bps rally across sovereign rate curves as economic data gave further credence to the notion that inflation has potentially peaked. 2s10s inverted by a similar amount in January and currently stand at historically low negative levels with markets increasingly thinking that central banks’ hiking policy is nearing an end. Within this conjecture, financials outperformed once again as higher rates directly feed into higher earnings; leading equity bank indices rose c.14% across Europe and the US, with credit spreads across the capital structure tightening by 40bps in Senior, 60bps in subordinated, and AT1s +4pts.
M&A was topical in the month ignited by a surprise headline that First Abu Dhabi Bank (FAB) was considering a bid for Standard Chartered. While the news was swiftly quashed within minutes, First Abu Dhabi Bank confirmed it did evaluate a possible offer for Standard Chartered but was no longer doing so. Since then, news reports linking FAB to Standard Chartered continue to linger with speculation that a deal could be revived upon the expiry of the mandatory 6 month restriction under the UK Takeover rules. More importantly, BNP’s sale of Bank West to BMO finally received the necessary regulatory approval and the transaction is now scheduled to close on 1 February. To recap, the sale is expected to free up c.100bps of capital with BNP set to confirm the exact financial impact during its 4Q22 results.
Amongst the first few 4Q results by leading European banks, UniCredit offered solid evidence of the positive upside from higher interest rates for European banks. Results came in significantly ahead of consensus across all key areas (c.95bps in capital and +10% in NII) which allowed management to lift its proposed distributions as well as its 2023 outlook. UniCredit shares encapsulated the strength of its 4Q22 results and closed up c.14% on the day with subordinated spreads c.20bps tighter making it one of the top performers in financials in January.
In the final window of early TLTRO repayments, European banks repaid €63bn in borrowings, far below market expectations of €213bn and down sharply from the €450bn in December. Following the repayment in January, TLTRO borrowings stand at €1.26tn, of which c.50% is set to mature by June 2023 which is when the largest tranche rolls off. For now we do not expect this repayment to have any significant impact on banks’ liquidity measures given the excess amount of deposits that exist across the European banking system and the (for now) relatively low beta of deposit repricing. This could change as the ECB remains on its hiking path and is worth close monitoring.
Financial Equity Strategy
The fund saw significant positive contributions from our positions in the US “bank tech” subset of the financial technology sector. These companies provide software and technology services to the banking industry. There are strong revenue growth tailwinds for this group as community banks and credit unions need to spend heavily on digital solutions to keep up with changing customer demand and preferences while competing with the likes of Bank of America, JPMorgan Chase, etc. The tailwinds are especially strong for smaller, more nimble players like our holdings Q2 (QTWO), nCino (NCNO), and Alkami Technology (ALKT) that can take share of a growing pie from larger, slower moving industry incumbents.
Throughout 2021 and 2022, these stocks derated dramatically amid Fed tightening, macroeconomic concerns, and contracting market multiples. Price declines of 60-80% created attractive entry points for long-term secular growth stories which also possess significant takeout potential given their valuable long-term contracts and recurring revenue streams. To that end, private equity firms have raised billions to deploy in the financial services software space over the next several years. The stocks have been strongly correlated to US monetary policy; as clarity regarding the end of the Fed hiking cycle has continued to emerge, along with increasing investor confidence in an economic soft landing, a substantial overhang has begun to recede helping the stocks recover strongly from depressed levels.