Monthly Commentaries

November 2023

Economic and investment highlights

Global Credit Strategy

How we did in November: The fund returned between 4.1% and 4.6% across different share classes, compared to EUR HY (BAML HE00 Index) 2.9%, US HY (BAML H0A0 Index) 4.6% and EM sovereign credit (BAML EMGB Index) 6.2%. Performance in November, gross of fees in EUR, was: (i) Credit: 4.4%, with 4.6% from cash bonds and -0.2% from CDS; (ii) Rates: 41bps; (iii) FX: 6bps, (iv) Equity: -12bps and (v) Other: 0bps.

What we are doing now: November was the strongest month for fixed income markets since 2020, helping our Fund performance. In September and October, we took advantage of wide rates and weak credit risk to add duration and remove hedges. As a result, we entered the month long rates and risk, and delivered strong performance across all portfolio areas. The Fund is now up 9.3% in EUR YTD, in line with the best performing areas within fixed income markets.

The driver of asset prices in November was an attenuation of economic strength, which stabilized interest rates. The re-pricing was almost too quick: the front end of US and EU curve are now pricing five cuts in 2024, and high-yield credit spreads are at one-year tights. Valuations thus factor in a scenario where the global economy slows down but avoids a recession, and central banks are still able to cut thanks to lower inflation. We recognize that current momentum may extend in January, but we make the portfolio less geared towards this “goldilocks” scenario, as much is in the price.

At November month end, net credit exposure is 94%, or c.5% below one month ago. Rates duration is 4.2y, vs 5.2y at the end of October.

More in detail:

  • The Fund blended YTC is 9.6%, with average rating BB+.
  • The Fund duration is now 4.2y, 1y lower than in late October. We have brought down to zero our 2y rates longs in Europe and US, and reduced conviction on longer-end tenors. We have reduced long-end cash bonds which performed strongly in November.
  • Our net exposure is 94%. We have reduced hedges in late October, and added back some in late November. We currently have c.10% in hedges on European and US CDS.
  • Net exposure in financials (incl. cash short and single name CDS) represents 47% of the book. We continue to focus on subordinated debt of selected names in Europe, but recently reduced the top performing position. We participated in several new deals in November, all up 3-5 points.
  • Net corporates exposure (incl. cash short and single name CDS) represents 37% of the book. In Europe, we focus on 8-10% yielding bonds backed by a solid pool of hard assets and at valuations that heavily discount the underlying value. In corporates, we focus idiosyncratic catalysts, and it remains the cash portfolio portion with lower market beta.
  • Net EM exposure (incl. cash short and single name CDS) represents 15% of the book. EM rallied hard in November and local markets, which we favour, outperformed MTD and YTD. We reduced selected long-dated bonds and hedged back a portion of higher beta currencies. We are adding risk in local markets with idiosyncratic drivers (e.g. Turkey).

Financial Credit Strategy

The FED’s decision to hold rates unchanged for a third consecutive meeting coupled with a continuous softening in inflation and other economic datapoints triggered one of the largest monthly risk-on rallies. With US 10-year rates tightening some 60bps, global equity indices on average moved c8% higher, bumping YTD total returns to anywhere from 20% to over 45%. Performance in November across the financial landscape was not too dissimilar from the broader market in Europe though the US outperformed with regionals c15% higher (still -20% YTD).

Credit markets stood out with indices generically outperforming most other risk asset classes as spreads rallied c20% with some slight 10-15bps curve inversion. In financials, subordinated capital outperformed senior funding, with spreads for T2s tightening c50bps versus c35bps for seniors. AT1s rallied in excess of 4pts, and spreads moved c120bps off their historic wides; at almost 600bps, we remain of the view there is significant room for further spread compression, even if just to the c500bps mid-point of the trading range.

November saw the end of the 3Q23 results season for European financials with trends remaining roughly unchanged from peers that had reported earlier in October. The better-than-expected performance of asset quality continues to surprise positively with the only real signs of deterioration cropping up in specific pockets of commercial real estate in the US, Nordics, and Germany.

There were further positive actions by rating agencies across both sovereigns and individual entities. Unquestionably the main event was the long-awaited potential junking decision of Italy but this was averted and made more remote with the outlook changed from negative to stable. In addition, some of the historically more challenged banks in Italy and Portugal saw double upgrades to their base ratings, testament of the significant fundamental improvement in operating metrics.

Primary activity picked up into November with European financials issuing EUR55bn across their entire capital structures. Although senior continued to account for the majority (c80%), focus was on capital instruments with over EUR10bn issued, the most active month since this time last year. More specifically, AT1s were in the spotlight with the reopening of the market via a handful of transactions; at EUR9bn it was the busiest month in at least the last 5 years. We expect issuance to subside into year-end before picking up again in January given the habitual front-loading done by institutions, even more so next year due to political events in 2H24.

Financial Equity Strategy

Financials modestly outperformed during November as the financial conditions eased dramatically and the market continued to digest primarily better earnings in Europe vs a still uncertain top-down backdrop. While 3Q reporting was far from uniform, at the European sector level it was another quarter that delivered incremental upgrades to consensus earnings expectations for banks (SX7P EPS +c.1% vs pre-3Q results). The other material change during November has been the sharp turnaround in market rate expectations with 4Q24 futures currently pointing to rates c.90bp lower than previously priced at end-September.

While the top-down environment (and reaction function of centrals banks) remains uncertain we are cognisant that current data trends point to potential for rate cuts to come through more quickly. As such, bottom-up stock selection will become even more important, and we have been positioning the portfolio across three main themes in Europe:

First, while we remain relatively agnostic at a geographic level in Europe, we have locked in profits in some of our rate play ‘winners’ and undertaken rotation towards less market-favoured names which have de-rated in recent months but which we think offer more diverse revenue drivers/specific catalysts going forward (e.g. greater fee driven activity which can recover momentum in 2024).

Secondly, we are not throwing the baby out with the bathwater and remain happy to continue to hold ‘rate plays’ that we think are underpinned by strong retail deposit franchises in concentrated markets (i.e. which can sustain preferential liability pricing dynamics) and/or where they have taken proactive steps to hedge against a future reduction in rates (thus still leaving scope for positive revisions vs consensus expectations). Many of these banks also offer the advantage of having defensive balance sheets from an asset quality point of view (with the recent Signa insolvency filing a reminder that one should expect defaults to creep up in a higher rate environment).

Finally, we continue to have an overarching preference for banks that offer strong dividend/buyback support. The European bank sector currently offers an all-in annual ‘yield’ (dividends plus buybacks) of c.12% – with many of our core holdings well in excess of this – and that remains a key reason for our positive view. At c.6x P/E we think the market is materially over-discounting any potential earnings headwinds from lower rates/weaker growth and while we recognize the unwind of this discount will likely still take time, we are happy being paid to wait via the substantial yield support.