Monthly Commentaries

June 2024

Economic and investment highlights

Global Credit Strategy

How we did in June: The fund returned between 0.20% and 0.00% across different share classes, compared to EUR HY (BAML HE00 Index) 0.5%, US HY (BAML H0A0 Index) 0.9% and EM sovereign credit (BAML EMGB Index) 0.4%. Performance in June, gross of fees in EUR, was: (i) Credit: 32bp, with 24bp from cash bonds and 8bp from CDS; (ii) Rates: 9bps; (iii) FX: 2bps, (iv) Equity: -19bps and (v) Other: 0bps.

What we are doing now: June was an eventful month, marked by significant macroeconomic data and pivotal election headlines globally. Overall, uncertainties surrounding the European political landscape led to an increase in credit spreads but also pushed down base rates, which ultimately drove positive performance in the credit market across asset classes. This result came despite continuously sound economic indicators pushing forward the trajectory for future cuts.

The Fed maintained its policy rate, reinforcing the higher-for-longer narrative. US inflation data were supportive of this narrative. The ECB’s rate 25bp rate cut to 3.75% was seen as hawkish, casting uncertainty on future policy amidst sustained services inflation and a solid US economy. Elections in Mexico, South Africa, and India, along with President Macron’s call for early French legislative elections, injected volatility into the markets. In the US, the first Presidential debate focused investor attention on November elections.

We continue to see selected opportunities in credit but like to maintain a high degree of protection, as valuations remain tight and macro vol is on the rise. Tight spreads and high all-in yields mean we need to sacrifice a moderate portion of our yield to own volatility. We currently give up ~70bp of yield to halve our net credit exposure, a trade-off which we consider attractive. Our blended YTC is 6%.

We run record cash levels of 15%. In June, we added risk in cash corporate credit and correspondingly reduced our exposure in EM. Exposure to financials keep coming lower, and it’s now 20% off the highs reached at the end of 2023.

We keep duration very moderate, at 2.8y.


More in detail:

  • The Fund blended YTC is 6%, with average rating of BBB-.
  • The Fund duration is now 2.8y, close to the average of our two-year range. We hold steepeners on the US curve.
  • Our net credit exposure is ~40%. We currently run 15% 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 31% 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 31% of the book. We focus on 7-9% yielding bonds backed by a solid pool of hard assets, at valuations that heavily discount the underlying value, or with imminent refinancing catalysts.
  • Net EM exposure (incl. cash short and single name CDS) represents 9% of the book. We have cut some risk ahead of US election noise and look to re-engage at better levels.


Financial Credit Strategy

June started on the front foot for risk assets as the ECB followed through with its much expected 25bp cut in interest rates. The decision to proceed despite the mixed data points on inflation from the prior month showed the ECB’s commitment to starting the rate cut cycle, even as it refused to commit to a pre-determined path for future cuts. Meanwhile the BOE held rates unchanged in June, albeit signaling that the threshold for a rate cut at the next meeting will be far less data dependent, leaving the UK central bank open for cuts in early August, four weeks after UK government elections. 

The positive sentiment eventually faded towards the end of month on the back of political developments. European Parliament elections, previously thought to be largely uneventful, turned out to be the opposite as French President Macron took the decision to call a snap legislative election following a drop of consensus to the benefit of Le Pen’s RN party. The move – which came after a sovereign rating downgrade took markets by surprise – led to a broad selloff in French risk assets.

Concerns around the loosening of fiscal spending under potential Left or Right government led to sharp widening in the 10Y OAT-Bund spreads, peaking at 80bps, levels last seen in 2011 during the European sovereign crisis as the French equity index declined -6.4% in the month. Banks underperformed broader equity indices in Europe by closing the month at -6.7%, with French banks the worst performers led by Societe Generale (-20%). In credit, French risk was in the spotlight and naturally underperformed with AT1s down between 0.5% and 1.5%; French Tier 2 and Senior spreads ended anywhere from 5bps to 15bps wider in the context of a broader Financial sector that was largely unchanged. 

With the first round of elections proving less favourable than previously expected for Le Pen’s RN, markets gave signs of relief going into the second round. While the outcome leaves some uncertainty around future economic and fiscal policies in the country and debt sustainability, the larger banks remain widely diversified geographically and well capitalized. So, while this is generally not positive for the sector in the medium term, with Macron retaining the President’s seat and France’s commitment to Europe not expected to be at risk, the solid fundamental backdrop of French banks leaves us comfortable on our credit exposures.

Regulatory updates were broadly positive in June for bank fundamentals. The EU confirmed that it would delay the application of the review of the trading books until January 2026, a much-awaited announcement that postpones some capital headwinds at major banks, including, notably the French. In another positive sign of confidence towards banks by European regulators, the ECB removed a long lived dividend ban on Greek institutions. Finally, the quarterly risk dashboard published by the EBA confirmed the solid fundamentals across the sector, with CET1 unchanged QoQ at 16% on average and NPLs stable at historic lows. So, while we keep expecting some deterioration in asset quality going forward, existing capital buffers, provisions and solid profitability (average ROE 10.6%) leave banks well equipped to cope with headwinds ahead, and our credit investment case unchanged.

Due to developments on the French electoral landscape in early June, primary activity was sharply curtailed with new deals capped at just EUR18bn, less than half of June’s average over the past five years. More than half of new issuance came in the Senior Preferred / Covered format, with capital making up just EUR4bn over 5 deals of which 4 were AT1s. Primary activity tends to ebb back in July due to banks’ earnings results blackouts. This could mean a wave of new issuance might come over the Summer before US elections get into full swing. We continue to anticipate that volatility will bring interesting opportunities for our funds.

Financial Equity Strategy

June was very much about political surprises, beginning with Macron’s call for snap parliamentary elections in France and ending with a very poor debate performance from President Biden which significantly reduced the probability of his reelection later this year. Indeed, such events have reminded the market that 2024 is the ‘year of elections’ with c.50% of the world’s population taking to the polls. It is difficult to divorce banks from their political backdrop given potential implications for growth, funding costs and asset quality. However, where market sentiment overlooks fundamentals, it can create attractive investment opportunities. The challenges facing the French economy (twin deficits, sluggish growth) are not new while the structure of domestic balance sheets means French banks aren’t beneficiaries of higher rates to the same extent as European peers. However, if base case expectations for a hung parliament/modest far-right majority and continued Macron presidency play out, it’s not clear we will see material spillover impacts to the broader European economy (or ECB reaction function) in the near-term. That makes recent weakness in some (non-French) European banks look particularly interesting. Individual stock selection is increasingly key, but we still think the investment case for the European bank sector remains highly attractive given continued earnings upgrades; annual yields in the form of dividends plus buybacks in double-digit territory; and valuations at a significant discount to their long-run average.

Meanwhile in the US we have seen YE25 Fed Funds rate expectations fall back down 3.9% from late May levels of >4.4%, as recent inflation prints have been more benign and growth data has started to show some signs of slowing. In our view, this potential soft landing – assuming it is not the early signs of a much more aggressive slowdown – could well be conducive to a more constructive backdrop for US banks than has been the case in some time. With many of the headwinds facing US banks – funding pressures, regulatory concerns, capital constraints – now starting to stabilize and even inflect more positively, it is notable that the stocks (particularly the smaller ones) continue to trade near absolute and relative valuation trough levels. Given the starting point, and very negative sentiment as well, the case for long exposure to the smaller US banks is starting to look more attractive. What could be most compelling for the space though is a red wave in November. This scenario, which now looks much more likely than just a few months ago, would likely unleash a wave of M&A in US banks just at the time that investors have given up on the group. Political risk cuts both ways: small US banks may well be one of the best and most undiscounted “Trump trades” in the market.