How we did in August: The fund returned between 1.13% and 0.69% across different share classes, compared to EUR HY (BAML HE00 Index) 1.2%, US HY (BAML H0A0 Index) 1.6% and EM sovereign credit (BAML EMGB Index) 2.7%. Performance in August, gross of fees in EUR, was: (i) Credit: 1.2%, with 1.3% from cash bonds and -11bp from CDS; (ii) Rates: 2bps; (iii) FX: -4bps, (iv) Equity: -8bps and (v) Other: 0bps.
What we are doing now: August started with a circuit breaker in global carry trades, triggered by the unwind of long risk positions funded in Japanese Yen, and fears about a US hard landing. The Fund was well positioned for this scenario: we entered the month with a good degree of equity and credit protection, low net exposure, a small long in the Japanese Yen and a small short in the Mexican Peso. We reduced protection in equities and FX post the first week, but remained overall light in risk, especially in credit, which moved the least.
Currently, we see markets as fragile. In early August, global yield curves started pricing cuts because risk assets started pricing recession. In the second half of the month, risk assets rallied but cuts remained priced. As such, market is now priced for goldilocks, a situation where risky assets price fine growth but central banks cut anyway. Something must give, either in duration or risk, or (most likely) a combination of both.
As a result, we keep net exposure relatively low, close to 40%, and add some protection in rates too. Fund duration is now 2y, vs almost 3y in July. Fiscal woes add to duration risks into US elections.
In credit, all-in yields remain high, but contracted meaningfully over the past month, as rates rallied and spreads tightened. Historically, it has been difficult to obtain good returns in credit starting from current spread levels. We therefore keep cash high and continue to focus on alpha more than beta in our bond allocation.
Our YTC remains 6% despite a low net exposure, as we run protection in tight indexes. We run 18% cash allocation. We reduced allocation to high beta areas such as Financials and EM.
More in detail:
The Fund blended YTC is 6%, with average rating of BBB-.
The Fund duration is now 2y.
Our net credit exposure is 44%. We currently run ~18% cash, and hold protection via US IG, US HY, EU HY, EM spreads.
Net exposure in financials (incl. cash short and single name CDS) represents 28% of the book. The asset class outperformed since October. We remain constructive but reduce some of the winners.
Net corporates exposure (incl. cash short and single name CDS) represents 33% of the book. We focus on high yielding bonds with limited exposure to market risk and a strong emphasis on catalysts. As a result, GCO corporate exposure has lower beta than corporate indexes and the rest of GCO book.
Net EM exposure (incl. cash short and single name CDS) represents 10% of the book. EM local is currently 3% of the fund.
Financial Credit Strategy
August was broadly positive for risk assets, albeit volatile at the start. Soft US economic data, in the form of a weak jobs report, a downward revision of prior months’ job prints and a tick-up in unemployment, led to some sharp moves across risk assets amid concerns of an impending economic slowdown. Rising expectations of earlier FED cuts, in the context of the end-July hike by the Bank of Japan, fuelled market volatility as the resulting move in JPY/USD triggered a rapid unwinding of sizeable Yen carry trades. Volatility reached its peak on August 5th, with equity markets sharply down across geographies and particularly in Japan (Nikkei -12%). Post August 5th, better economic data combined with BOJ and FED officials’ remarks led to a broad price recovery so that both the S&P500 (+2.4%) and Eurostoxx 600 (+1.6%) closed the month in positive territory, while Japanese equities ended the month down -1.1%.
Credit markets had another positive month in August, supported primarily by rates as expectations of dovish central banks remained a central positive catalyst for the asset class. Core rates rallied anywhere from 5bps to 25bps, broadly bull steepening across curves some 10bps, as the market continues to price in several rate cuts into year-end. In this environment, financial credit assets outperformed led by AT1s +1.5% on average, with more senior parts of the capital structure generating up to 50bps total return. It is noteworthy to flag that despite declining 70bps in August, European banks’ equity remains one of the better asset classes YTD at +28%.
European banks’ Q2 earnings season drew to a close in August. Results for the quarter confirmed the overall positive state of fundamentals, with resilience on the top line and an ongoing benign credit cycle, leaving loan losses close to recent lows. Investors’ attention is slowly turning to the 2025 outlook, focusing mainly on interest margins on the back of recent rate moves. While these are negative on NII, management teams are well aware and seemingly well prepared to offset this with a mix of volumes, hedges and fees. In specific news, DB announced that it had reached a settlement with nearly 60% of the plaintiffs in the Postbank litigation, which allows it to release some c.430m provisions set aside only a few months ago. This is positive for the stock, and for credit as well as removes a large piece of uncertainty on profits freeing up precious capital.
Primary activity was quite subdued in absolute terms in August coming in less than EUR18bn for leading European financial institutions. This was some 40% lower than the same month last year, in part due to heightened volatility at the start of the month when historically issuance is concentrated, and the fact that barring a few geographical exceptions, European banks are quite well through their funding and capital needs (c80% YTD).
It is worth noting that what was issued was concentrated in the capital format (EUR7bn, or 40% of the total) and met with quite strong demand from the institutional investor base. All things considered given that since 2018, capital issuance has averaged c15% of total primary activity. We expect there to be a pick-up in primary transactions in the first half of September as issuers complete their needs and consider volatility around potential events such as US elections, corrective fiscal decisions, and changes in Central Banks’ monetary policies.
Financial Equity Strategy
We had written about M&A earlier in the year (see our April 2024 commentary), and recent weeks have delivered further evidence that this is a developing theme in the global financials space that should not be ignored.
In Europe, BNP announced plans to acquire Axa’s asset management business at the beginning of August for €5.1bn. In a rare example of post-crisis regulation producing more favorable outcomes for banks, BNP is able to use its bancassurance model to its advantage – with the Axa business being acquired by BNP’s insurance arm it receives less onerous regulatory treatment under the so-called ‘Danish compromise’. This means capital consumption related to the acquisition is actually <€2bn and helps BNP guide to an ROIC of c.18% on the deal (a target that itself appears conservative given the likely synergies that can be extracted by merger with BNP’s own asset management business). Recent days also brought the announcement that Italian bank UniCredit had acquired a c.9% stake in German bank Commerzbank. We would not describe this as ‘cross-border’ M&A as such given UniCredit’s sizeable existing presence in Germany (but it is that presence that supports the strategic rationale of the move). Although it remains to be seen whether UniCredit will proceed with a full takeover bid, it is clear that management’s successful organic turnaround of the business to date provides greater strategic flexibility – UniCredit has meaningful excess capital with a 16.2% CET1 ratio and a favorable valuation at 1.1x P/TNAV (compared to CBK trading on 0.5x pre deal announcement).
As the initial sugar rush of a return to a more normalized interest rate environment fades, we expect to see increasingly differentiated profit performance across individual banks. This should provide further opportunities for well-run banks with disciplined management teams to take front-footed strategic actions and we will continue to look for the potential winners under this scenario. The opportunity is not limited to European banks, either. We suspect large insurance M&A will accelerate as large buyers in Asia unwind cross-shareholdings and free up capital to be deployed externally. With Lloyds’ names in the UK trading at sharp discounts and with digestible market caps, we would anticipate this to be one of the first ports of call for consolidation. Additionally, in the US, we see a significant pent-up demand for bank M&A as smaller institutions are finding it increasingly difficult to compete in the new regulatory regime. While the election this November will surely impact this, 2025-26 is very likely to see a much higher degree of bank M&A activity than in the past 5 years regardless of who wins the White House. We have seen a few deals already, including one of our own holdings, in recent months. The template is set with all-share deals with significant cost synergies and 20%+ EPS accretion. The opportunity for value creation is high for both buyers and sellers and so we would expect this to be an important theme for the portfolio over the next 12-24 month.
Sustainable Equity Strategy
Global equity markets closed August on an upward trend, after a significant correction in the first week of the month, which was then recovered in the second half of the month. The sell-off in the stock markets that characterized the first part of the month has completely reversed, as recent signals from the United States and Powell’s speech at Jackson Hole did not confirm the concerns about an impending recession triggered by the weak July labour market report. There has been a loss of momentum in Europe and China in recent months, caused by weakening global manufacturing indicators. In the US, GDP growth continues at a solid pace (with the Atlanta Fed’s 3Q24 annualized real GDP estimate at +2%), albeit slower than in recent quarters, and labour demand has shown signs of slowdown. For this reason, the upcoming macro data will be closely monitored by the market. In the US, in his Jackson Hole speech, Powell virtually confirmed a rate cut in September. Markets have slightly raised expectations of a rate cut for 2024 and 2025 and are now pricing in a 35% chance for a 50bps cut this September compared to 25% before the speech. On the US election front, current polls show that Harris would have a few percentages points advantage over Trump, but the September 10 debate will be a crucial date.
The fund closed the month with a nice +0.93% return after a solid first half 2024 performance of ca 11% (B EUR share class). The return for the month has been driven by the strong performance of Hitachi (Japanese conglomerate mainly active in green energy and digital services), Prysmian (world leader in energy and telecom cables) and Stryker (US company which develops, manufactures, and markets specialty surgical and medical products).
The performance has been driven by our top-down fundamental approach due to 1/ significant EPS acceleration in light of the remarkable resilience of the global economy especially for the ESG themes we play out, 2/ inflation converging back towards its targets and ability to companies in our portfolio to keep strong gross margins 3/ strong FCF generation giving opportunities of M&A.
In terms of strategy, the Fund is a concentrated portfolio, investing in long-term quality growth companies, with strong competitive advantages, strong pricing power, significant barriers to entry, solid balance sheets and healthy free cashflow generation which they can reinvest and thus generate high return on capital employed.
Global Credit Strategy
How we did in August: The fund returned between 1.13% and 0.69% across different share classes, compared to EUR HY (BAML HE00 Index) 1.2%, US HY (BAML H0A0 Index) 1.6% and EM sovereign credit (BAML EMGB Index) 2.7%. Performance in August, gross of fees in EUR, was: (i) Credit: 1.2%, with 1.3% from cash bonds and -11bp from CDS; (ii) Rates: 2bps; (iii) FX: -4bps, (iv) Equity: -8bps and (v) Other: 0bps.
What we are doing now: August started with a circuit breaker in global carry trades, triggered by the unwind of long risk positions funded in Japanese Yen, and fears about a US hard landing. The Fund was well positioned for this scenario: we entered the month with a good degree of equity and credit protection, low net exposure, a small long in the Japanese Yen and a small short in the Mexican Peso. We reduced protection in equities and FX post the first week, but remained overall light in risk, especially in credit, which moved the least.
Currently, we see markets as fragile. In early August, global yield curves started pricing cuts because risk assets started pricing recession. In the second half of the month, risk assets rallied but cuts remained priced. As such, market is now priced for goldilocks, a situation where risky assets price fine growth but central banks cut anyway. Something must give, either in duration or risk, or (most likely) a combination of both.
As a result, we keep net exposure relatively low, close to 40%, and add some protection in rates too. Fund duration is now 2y, vs almost 3y in July. Fiscal woes add to duration risks into US elections.
In credit, all-in yields remain high, but contracted meaningfully over the past month, as rates rallied and spreads tightened. Historically, it has been difficult to obtain good returns in credit starting from current spread levels. We therefore keep cash high and continue to focus on alpha more than beta in our bond allocation.
Our YTC remains 6% despite a low net exposure, as we run protection in tight indexes. We run 18% cash allocation. We reduced allocation to high beta areas such as Financials and EM.
More in detail:
Financial Credit Strategy
August was broadly positive for risk assets, albeit volatile at the start. Soft US economic data, in the form of a weak jobs report, a downward revision of prior months’ job prints and a tick-up in unemployment, led to some sharp moves across risk assets amid concerns of an impending economic slowdown. Rising expectations of earlier FED cuts, in the context of the end-July hike by the Bank of Japan, fuelled market volatility as the resulting move in JPY/USD triggered a rapid unwinding of sizeable Yen carry trades. Volatility reached its peak on August 5th, with equity markets sharply down across geographies and particularly in Japan (Nikkei -12%). Post August 5th, better economic data combined with BOJ and FED officials’ remarks led to a broad price recovery so that both the S&P500 (+2.4%) and Eurostoxx 600 (+1.6%) closed the month in positive territory, while Japanese equities ended the month down -1.1%.
Credit markets had another positive month in August, supported primarily by rates as expectations of dovish central banks remained a central positive catalyst for the asset class. Core rates rallied anywhere from 5bps to 25bps, broadly bull steepening across curves some 10bps, as the market continues to price in several rate cuts into year-end. In this environment, financial credit assets outperformed led by AT1s +1.5% on average, with more senior parts of the capital structure generating up to 50bps total return. It is noteworthy to flag that despite declining 70bps in August, European banks’ equity remains one of the better asset classes YTD at +28%.
European banks’ Q2 earnings season drew to a close in August. Results for the quarter confirmed the overall positive state of fundamentals, with resilience on the top line and an ongoing benign credit cycle, leaving loan losses close to recent lows. Investors’ attention is slowly turning to the 2025 outlook, focusing mainly on interest margins on the back of recent rate moves. While these are negative on NII, management teams are well aware and seemingly well prepared to offset this with a mix of volumes, hedges and fees. In specific news, DB announced that it had reached a settlement with nearly 60% of the plaintiffs in the Postbank litigation, which allows it to release some c.430m provisions set aside only a few months ago. This is positive for the stock, and for credit as well as removes a large piece of uncertainty on profits freeing up precious capital.
Primary activity was quite subdued in absolute terms in August coming in less than EUR18bn for leading European financial institutions. This was some 40% lower than the same month last year, in part due to heightened volatility at the start of the month when historically issuance is concentrated, and the fact that barring a few geographical exceptions, European banks are quite well through their funding and capital needs (c80% YTD).
It is worth noting that what was issued was concentrated in the capital format (EUR7bn, or 40% of the total) and met with quite strong demand from the institutional investor base. All things considered given that since 2018, capital issuance has averaged c15% of total primary activity. We expect there to be a pick-up in primary transactions in the first half of September as issuers complete their needs and consider volatility around potential events such as US elections, corrective fiscal decisions, and changes in Central Banks’ monetary policies.
Financial Equity Strategy
We had written about M&A earlier in the year (see our April 2024 commentary), and recent weeks have delivered further evidence that this is a developing theme in the global financials space that should not be ignored.
In Europe, BNP announced plans to acquire Axa’s asset management business at the beginning of August for €5.1bn. In a rare example of post-crisis regulation producing more favorable outcomes for banks, BNP is able to use its bancassurance model to its advantage – with the Axa business being acquired by BNP’s insurance arm it receives less onerous regulatory treatment under the so-called ‘Danish compromise’. This means capital consumption related to the acquisition is actually <€2bn and helps BNP guide to an ROIC of c.18% on the deal (a target that itself appears conservative given the likely synergies that can be extracted by merger with BNP’s own asset management business). Recent days also brought the announcement that Italian bank UniCredit had acquired a c.9% stake in German bank Commerzbank. We would not describe this as ‘cross-border’ M&A as such given UniCredit’s sizeable existing presence in Germany (but it is that presence that supports the strategic rationale of the move). Although it remains to be seen whether UniCredit will proceed with a full takeover bid, it is clear that management’s successful organic turnaround of the business to date provides greater strategic flexibility – UniCredit has meaningful excess capital with a 16.2% CET1 ratio and a favorable valuation at 1.1x P/TNAV (compared to CBK trading on 0.5x pre deal announcement).
As the initial sugar rush of a return to a more normalized interest rate environment fades, we expect to see increasingly differentiated profit performance across individual banks. This should provide further opportunities for well-run banks with disciplined management teams to take front-footed strategic actions and we will continue to look for the potential winners under this scenario. The opportunity is not limited to European banks, either. We suspect large insurance M&A will accelerate as large buyers in Asia unwind cross-shareholdings and free up capital to be deployed externally. With Lloyds’ names in the UK trading at sharp discounts and with digestible market caps, we would anticipate this to be one of the first ports of call for consolidation. Additionally, in the US, we see a significant pent-up demand for bank M&A as smaller institutions are finding it increasingly difficult to compete in the new regulatory regime. While the election this November will surely impact this, 2025-26 is very likely to see a much higher degree of bank M&A activity than in the past 5 years regardless of who wins the White House. We have seen a few deals already, including one of our own holdings, in recent months. The template is set with all-share deals with significant cost synergies and 20%+ EPS accretion. The opportunity for value creation is high for both buyers and sellers and so we would expect this to be an important theme for the portfolio over the next 12-24 month.
Sustainable Equity Strategy
Global equity markets closed August on an upward trend, after a significant correction in the first week of the month, which was then recovered in the second half of the month. The sell-off in the stock markets that characterized the first part of the month has completely reversed, as recent signals from the United States and Powell’s speech at Jackson Hole did not confirm the concerns about an impending recession triggered by the weak July labour market report. There has been a loss of momentum in Europe and China in recent months, caused by weakening global manufacturing indicators. In the US, GDP growth continues at a solid pace (with the Atlanta Fed’s 3Q24 annualized real GDP estimate at +2%), albeit slower than in recent quarters, and labour demand has shown signs of slowdown. For this reason, the upcoming macro data will be closely monitored by the market. In the US, in his Jackson Hole speech, Powell virtually confirmed a rate cut in September. Markets have slightly raised expectations of a rate cut for 2024 and 2025 and are now pricing in a 35% chance for a 50bps cut this September compared to 25% before the speech. On the US election front, current polls show that Harris would have a few percentages points advantage over Trump, but the September 10 debate will be a crucial date.
The fund closed the month with a nice +0.93% return after a solid first half 2024 performance of ca 11% (B EUR share class). The return for the month has been driven by the strong performance of Hitachi (Japanese conglomerate mainly active in green energy and digital services), Prysmian (world leader in energy and telecom cables) and Stryker (US company which develops, manufactures, and markets specialty surgical and medical products).
The performance has been driven by our top-down fundamental approach due to 1/ significant EPS acceleration in light of the remarkable resilience of the global economy especially for the ESG themes we play out, 2/ inflation converging back towards its targets and ability to companies in our portfolio to keep strong gross margins 3/ strong FCF generation giving opportunities of M&A.
In terms of strategy, the Fund is a concentrated portfolio, investing in long-term quality growth companies, with strong competitive advantages, strong pricing power, significant barriers to entry, solid balance sheets and healthy free cashflow generation which they can reinvest and thus generate high return on capital employed.