How we did in October: The fund returned between 2.4% and 2.7% across the different share classes, compared to EUR HY (BAML HE00 Index) 1.7%, US HY (BAML H0A0 Index) 2.8% and EM sovereign credit (BAML EMGB Index) 0.4%. Performance in October, gross of fees in EUR, was: (i) Credit: 235bps, with 176bps from cash and 59bps from CDS; (ii) Rates: -19bps; (iii) FX: -1bps, (iv) Equity: 52bps and (v) Other: 0bps
October was a strong month in credit and equities, driven by broad rates stability. Market participants unwound hedges whilst holding back on investing in cash credit, leading to an outperformance in CDS vs cash.
What are we doing now: positioning described by the following points.
The fund is 87% net invested in credit and has a total duration of 2.6y. The Fund’s blended YTM is 7.8%.
Our view, held since July, is that credit spreads factor in too high a chance of recession. Since late September, we believe that duration appears stretched vs likely inflation and central banks’ behaviour.
Net credit investment was raised in July, and we have kept it flat (at relatively high levels) since then.
Fund duration is at its highest in 2022, 1.5y above July.
On the cash credit book, we focus on quality, low leverage names across credit asset classes, with bonds yielding 7-8%, gaining exposure to high market beta with low individual credit risk. Higher risk/reward positions are held in AT1 bonds.
We focus on senior and tier 2 credits in US financials, AT1s in European financials, Telcos/quality in corporates and BBB/BB USD sovereigns in EM.
We have been exiting rates hedges and long USD trades. We added some longs in EM rates and some short USD expressions.
Shorts focus on the consumer and real estate sectors in Europe and countries with high refinancing needs in EM.
Financial Credit Strategy
October was the month of reversal for risk assets. Having started on a similar footing to the previous month, the tone shifted sharply mid-month on speculation that central banks might be finally pivoting away from their approach of rapid rate hikes. Speculation of a pivot in monetary stance (again) was initially floated by a WSJ report which suggested that FOMC could start signalling smaller rate increases alongside the all-but-certain 75bps hike at the upcoming November meeting. The subsequent decision by the Bank of Canada to only hike by 50bps instead of 75bps, coupled with dovish comments during the ECB press conference only further fuelled the pivot trade. Beyond financial markets, the outperformance of risk assets was also supported by the waning threat of a nuclear escalation from the war between Russia and Ukraine whilst a combination of full storage and warmer weather in Europe contributed to the -35% slide in natural gas prices in October.
Financial equities outperformed broader indices for a consecutive month as their 3Q results only affirmed their improving revenue outlook from higher rates. European banks climbed +8.4% outpacing the +6.4% recovery in the Stoxx 600 with its US counterparts up +12% against +8.1% for the S&P 500. Sovereign rates were broadly stable in October with the exception of gilts which rallied almost 100bps from its peak following the reversal of the mini-budget and the swift replacement of the Prime Minister. A new fiscal statement for the UK will now be presented on the 17 November in order to address its finances. Within the financial credit space, spreads in Seniors and Subordinated widened by c25bps and c50bps respectively whereas AT1 rallied 3pts driven by the broader risk appetite.
Third quarter results for European banks highlighted further momentum in profitability from rising interest rates as shown by consistent beats in net interest income, up +6% on an aggregate basis. These NII improvements in the third quarter also outpaced any increase in provisions which was generally a miss against consensus and predominantly driven by UK banks who had chosen to front-load their provisions in response to the weaker economic outlook. In the rest of Europe, provision overlays were more limited as banks continued to see very limited signs of credit deterioration given the relatively more benign outlook for rates. In addition, European banks also had a cloud of uncertainty lifted in October when the ECB took the pragmatic approach in amending the rate of the TLTRO programme from 23 November. Whilst the changes may erode the benefits of TLTRO, the trade-off in terms of three repayment dates ahead of maturity gives European banks the flexibility to repay if needed.
Primary across European financials was seasonally weaker as expected in October due to blackout periods ahead of third quarter results. Furthermore, given the ongoing uncertainty in markets, issuance was largely concentrated in the Senior part of the capital structure, with some issuers have started resorting to shorter (duration-wise) and more senior (Covered and Preferred) issuances in order to not lock into higher funding costs for longer. Ahead of year-end we expect one final flurry of primary activity as issuers round-out their plans in order to meet previously disclosed targets. This month’s outperformance of AT1s compared with other parts of the capital structure could embolden some European financials to access the capital markets.
Financial Equity Strategy
After the turmoil of a high CPI print, LDI pension crisis in the UK, and ongoing rate hikes in September, global stock markets rallied in October, with the MSCI ACWI up 6.1% during the month. Financials outperformed the market, with the ACWI Fins rising 7.8% during the month. The sector was led by banks, which delivered strong earnings results in both Europe and the US and continued to benefit from the continually underappreciated tailwind of higher interest rates. Despite global recession fears, the global Financials sector has outperformed the overall market by 650 basis points year to date on the strength of higher rates and resilient credit conditions.
The Financial Equity Fund was up 10.3% in October, bolstered by core positions in European and US banks. In Europe, we saw our largest contributions to performance from Deutsche Bank, Santander, and Unicredit. European banks’ 3Q22 results have been strong across the board. Net interest income has beaten consensus growth numbers by 5%, demonstrating the positive impact of rising interest rates and leading to earnings upgrades, whilst capital and asset quality have been solid. Analysts and companies are baking in higher cost growth from inflationary pressure and higher precautionary provisions for next year. Nonetheless, the strength of the interest rate benefits has offset the worse macro environment, leading to overall upgrades. Not what most investors were expecting but more in-line with our positive views. Following these earnings upgrades, the sector trades at an astonishingly low multiple both on an absolute (5.5x) and relative (55%) basis. And unlike in past instances where valuations have reached this low level, the ECB is hiking (not cutting), and the banks are paying out massive amounts of capital, with key holdings such as ING, NatWest, and Unicredit all expected to payout over 40% of today’s market cap through 2024.
In the US, our biggest contributions came from positions in the money center banks, which we had significantly increased exposure to ahead of the 3Q earnings season. Our view was that the banks would be able to assuage concerns on capital, credit, and rate sensitivity, and indeed they were able to show progress on all fronts, leading to extremely strong performance in stocks with JPM for instance up 22% in the two weeks after reporting. We also saw solid performance from regional bank holdings such as Citizens and Webster, which delivered better than expected earnings results and benefitted from strong outlooks on net interest income and deposit costs, improving capital positions, and an unwind in pessimistic sentiment. Perhaps most encouragingly, many of our key US bank holdings are locking in the benefit of higher rates, protecting their future earnings from potential future Fed rate cuts while maintaining sensitivity to the upside. A case in point is Citizens, our largest regional bank holding. Their NIM had peaked at 3.27% in 4Q18 during the last rate hike cycle, then plummeted nearly 60 bps as the Fed cut rates back to zero. This quarter, after smart balance sheet management, they disclosed that their NIM should rise above 3.5% next year and have a floor of 3.25% even if the Fed were to cut rates 200 bps – essentially, the prior cycle’s NIM ceiling is this cycle’s floor. This is extremely positive as it sets a substantially higher floor for earnings power in any rate backdrop, and despite this the stock seems to be implying a much more cyclical earnings stream with a paltry 7x multiple.
Global credit strategy
How we did in October: The fund returned between 2.4% and 2.7% across the different share classes, compared to EUR HY (BAML HE00 Index) 1.7%, US HY (BAML H0A0 Index) 2.8% and EM sovereign credit (BAML EMGB Index) 0.4%. Performance in October, gross of fees in EUR, was: (i) Credit: 235bps, with 176bps from cash and 59bps from CDS; (ii) Rates: -19bps; (iii) FX: -1bps, (iv) Equity: 52bps and (v) Other: 0bps
October was a strong month in credit and equities, driven by broad rates stability. Market participants unwound hedges whilst holding back on investing in cash credit, leading to an outperformance in CDS vs cash.
What are we doing now: positioning described by the following points.
Financial Credit Strategy
October was the month of reversal for risk assets. Having started on a similar footing to the previous month, the tone shifted sharply mid-month on speculation that central banks might be finally pivoting away from their approach of rapid rate hikes. Speculation of a pivot in monetary stance (again) was initially floated by a WSJ report which suggested that FOMC could start signalling smaller rate increases alongside the all-but-certain 75bps hike at the upcoming November meeting. The subsequent decision by the Bank of Canada to only hike by 50bps instead of 75bps, coupled with dovish comments during the ECB press conference only further fuelled the pivot trade. Beyond financial markets, the outperformance of risk assets was also supported by the waning threat of a nuclear escalation from the war between Russia and Ukraine whilst a combination of full storage and warmer weather in Europe contributed to the -35% slide in natural gas prices in October.
Financial equities outperformed broader indices for a consecutive month as their 3Q results only affirmed their improving revenue outlook from higher rates. European banks climbed +8.4% outpacing the +6.4% recovery in the Stoxx 600 with its US counterparts up +12% against +8.1% for the S&P 500. Sovereign rates were broadly stable in October with the exception of gilts which rallied almost 100bps from its peak following the reversal of the mini-budget and the swift replacement of the Prime Minister. A new fiscal statement for the UK will now be presented on the 17 November in order to address its finances. Within the financial credit space, spreads in Seniors and Subordinated widened by c25bps and c50bps respectively whereas AT1 rallied 3pts driven by the broader risk appetite.
Third quarter results for European banks highlighted further momentum in profitability from rising interest rates as shown by consistent beats in net interest income, up +6% on an aggregate basis. These NII improvements in the third quarter also outpaced any increase in provisions which was generally a miss against consensus and predominantly driven by UK banks who had chosen to front-load their provisions in response to the weaker economic outlook. In the rest of Europe, provision overlays were more limited as banks continued to see very limited signs of credit deterioration given the relatively more benign outlook for rates. In addition, European banks also had a cloud of uncertainty lifted in October when the ECB took the pragmatic approach in amending the rate of the TLTRO programme from 23 November. Whilst the changes may erode the benefits of TLTRO, the trade-off in terms of three repayment dates ahead of maturity gives European banks the flexibility to repay if needed.
Primary across European financials was seasonally weaker as expected in October due to blackout periods ahead of third quarter results. Furthermore, given the ongoing uncertainty in markets, issuance was largely concentrated in the Senior part of the capital structure, with some issuers have started resorting to shorter (duration-wise) and more senior (Covered and Preferred) issuances in order to not lock into higher funding costs for longer. Ahead of year-end we expect one final flurry of primary activity as issuers round-out their plans in order to meet previously disclosed targets. This month’s outperformance of AT1s compared with other parts of the capital structure could embolden some European financials to access the capital markets.
Financial Equity Strategy
After the turmoil of a high CPI print, LDI pension crisis in the UK, and ongoing rate hikes in September, global stock markets rallied in October, with the MSCI ACWI up 6.1% during the month. Financials outperformed the market, with the ACWI Fins rising 7.8% during the month. The sector was led by banks, which delivered strong earnings results in both Europe and the US and continued to benefit from the continually underappreciated tailwind of higher interest rates. Despite global recession fears, the global Financials sector has outperformed the overall market by 650 basis points year to date on the strength of higher rates and resilient credit conditions.
The Financial Equity Fund was up 10.3% in October, bolstered by core positions in European and US banks. In Europe, we saw our largest contributions to performance from Deutsche Bank, Santander, and Unicredit. European banks’ 3Q22 results have been strong across the board. Net interest income has beaten consensus growth numbers by 5%, demonstrating the positive impact of rising interest rates and leading to earnings upgrades, whilst capital and asset quality have been solid. Analysts and companies are baking in higher cost growth from inflationary pressure and higher precautionary provisions for next year. Nonetheless, the strength of the interest rate benefits has offset the worse macro environment, leading to overall upgrades. Not what most investors were expecting but more in-line with our positive views. Following these earnings upgrades, the sector trades at an astonishingly low multiple both on an absolute (5.5x) and relative (55%) basis. And unlike in past instances where valuations have reached this low level, the ECB is hiking (not cutting), and the banks are paying out massive amounts of capital, with key holdings such as ING, NatWest, and Unicredit all expected to payout over 40% of today’s market cap through 2024.
In the US, our biggest contributions came from positions in the money center banks, which we had significantly increased exposure to ahead of the 3Q earnings season. Our view was that the banks would be able to assuage concerns on capital, credit, and rate sensitivity, and indeed they were able to show progress on all fronts, leading to extremely strong performance in stocks with JPM for instance up 22% in the two weeks after reporting. We also saw solid performance from regional bank holdings such as Citizens and Webster, which delivered better than expected earnings results and benefitted from strong outlooks on net interest income and deposit costs, improving capital positions, and an unwind in pessimistic sentiment. Perhaps most encouragingly, many of our key US bank holdings are locking in the benefit of higher rates, protecting their future earnings from potential future Fed rate cuts while maintaining sensitivity to the upside. A case in point is Citizens, our largest regional bank holding. Their NIM had peaked at 3.27% in 4Q18 during the last rate hike cycle, then plummeted nearly 60 bps as the Fed cut rates back to zero. This quarter, after smart balance sheet management, they disclosed that their NIM should rise above 3.5% next year and have a floor of 3.25% even if the Fed were to cut rates 200 bps – essentially, the prior cycle’s NIM ceiling is this cycle’s floor. This is extremely positive as it sets a substantially higher floor for earnings power in any rate backdrop, and despite this the stock seems to be implying a much more cyclical earnings stream with a paltry 7x multiple.