How we did in October: The fund returned between 0.18% and -0.15% across different share classes, compared to EUR HY (BAML HE00 Index) 0.6%, US HY (BAML H0A0 Index) -0.6% and EM sovereign credit (BAML EMGB Index) -2.1%. Performance in October, gross of fees in EUR, was: (i) Credit: -30bps, with -28% from cash bonds and -2bps from CDS; (ii) Rates: 47bps; (iii) FX: 3bps, (iv) Equity: 1bps and (v) Other: 0bps.
What we are doing now: We entered October with low duration and a light net exposure. We warned in September that duration rallies tend to exhaust post first Fed cut and 2024 made no exception. US elections jitters added to pressure on duration.
The outcome of US elections means fixed income will continue to be a difficult market. Republican policies are inflationary and deficit-enhancing, and the vote gives the new administration a strong mandate to carry them out. US inflation breakevens have been on the move, but 80bp of cuts are still priced into 2025. The US curve is still flat from a historical standpoint. Markets aren’t fully pricing yet the impact of Republican policies, setting the stage for more rates volatility in the coming months.
In this environment, we maintain a cautious approach despite the mild repricing in global rates. Our duration is at 2.3y and our net exposure is on the low side of historical range. The bulk of our duration exposure lies in Europe, where implications of the US vote are less bullish.
Credit spreads have been strong so far, but we don’t find credit beta attractive. First, the next leg on UST repricing could put pressure on cash credit, impacting spreads. Second, a trade war is negative for global growth and ultimately for spreads, especially starting from tight valuations. Dispersion in credit markets has reduced over the past three months but remains high, meaning the market still presents opportunities. We maintain a low beta and focus on alpha generation in relatively high-yielding segments of the credit market.
Our blended YTC is 5.6% despite limited net exposure. We run 17% cash allocation and 42% net credit exposure. The Fund is therefore set-up to deliver small but decent returns in a stable market and has plenty of resources to deploy in a market selloff.
More in detail:
The Fund blended YTC is 5.6%, with average rating of BBB-.
The Fund duration is now 2.3y, below our two-year average.
Our net credit exposure is 43%. We currently run ~16% 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 strongly over the past twelve months. We remain constructive but reduce some of the winners.
Net corporates exposure (incl. cash short and single name CDS) represents 34% 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 11% of the book. EM local is currently 3% of the fund.
Financial Credit Strategy
October proved to be a rather mixed month for risk assets, steered by a combination of elevated geopolitical tensions in the Middle East and the continued refinement in rate cut expectations by the market. The latter featured a consecutive 25bps rate cut by the ECB at their monthly meeting whereas a stronger economic outlook and more robust core CPI readings in the USA pared rate cuts expectations down to under 50bps for the remainder of 2024.
This growing divergence in rate paths was reflected in the performance of financial equities with the SX7E in Europe rising just 0.6% compared to +6.5% for the BKX in the USA, taking the total return year-to-date for both to 30%. In credit, AT1s were largely unchanged with the more senior parts of the capital structure including Tier 2s tightening by 5-10 bps spread-wise.
European banks kicked off their third quarter reporting season pretty much where they left off in the previous quarter. Underlying operating trends remain robust with income across net interest and fees relatively stable and holding up better than expected. Disciplined cost control and lack of deterioration in asset quality are the other two pillars that ensure ongoing capital generation, thereby strengthening the sector further to sequentially better levels. Guidance for the remainder of this year and next year have been either reiterated or upgraded, further proof of the uniqueness of the financial sector vis-à-vis others such as corporates and high yield.
In contrast to Outlook downgrades across some core European countries, there were largely positive rating actions across peripheral European countries as the latter have continued to progressively surprise on a multitude of key fronts including economic growth, fiscal discipline, and political stability. This should bode well for further narrowing of spreads between these two parts especially as investors seek to diversify away from core European exposure given what could be a bumpy few quarters.
October’s primary activity was subdued at just EUR20bn due to the blackout period ahead of third quarter results, the significant pre-funding that has taken place year-to-date, and the increasing geopolitical uncertainty arising from US elections. A few AT1 transactions issued in the month was still met with decent demand by investors as the asset class continues to attract support despite the tighter spreads of the new instruments. Although the issuance calendar for capital instruments should be largely complete this year, we still expect a handful of transactions into year-end as some should opportunistically take advantage of current levels.
Financial Equity Strategy
During October, US banks outperformed a slightly negative S&P 500 with large banks up nearly 7% and smaller peers up 4% as third quarter earnings reports and updated management outlooks were generally better than expected. Bank stocks were buoyed as well by increasing optimism around a potential victory by Donald Trump in the November presidential election. That victory, and a better showing by the Republican party in Congressional races, has indeed come to fruition and the banks have rallied hard as a result. The BKX is up 11% and smaller banks more so in the four days since the election with several factors driving the positive momentum. A more favorable regulatory environment is at the top of the list given that Trump will have the ability to remove the leadership of numerous regulatory agencies in relatively short order. It is expected that new regulatory leaders will be more open to M&A, including at the regional bank level, which would mark a stark contrast from recent years which have seen limited deal activity. Moreover, the Basel III Endgame proposal will likely be meaningfully watered down from its original form, if not scuttled altogether. While it is unclear what a finalized rule may look like, reduced risk-weighted asset inflation could lead to increased capital return over the next several years.
In addition to regulatory relief, the bull case on US banks assumes that Trump’s policies will increase economic growth, leading to higher loan demand along with the continuation of benign credit costs. Lastly, a steeper rate curve should support interest income as lower rate assets roll off into higher yielding loans and securities. While these tailwinds may materialize, it is difficult to discern the magnitude of earnings improvement they will drive. During Trump’s first term, the government’s appetite to cut taxes was clear and the corporate tax rate fell meaningfully from 35% to 21%, leading to over 20% EPS accretion for many banks. Even if the rate is lowered further from 21% to 15% as Trump hopes, but which will likely be very challenging to pass through Congress, this represents a mid-to-high single digit increase to earnings estimates, just a third of the impact of first corporate tax cut. It was also already expected that Basel III would be watered down in some form, so some benefit has been priced in. Before the stock rally post-election, banks had already moved notably higher since the Presidential debate in June, without a matching increase in estimates. As such, the P/E multiple of the BKX using 2026 estimates has increased by nearly 40% on average since mid-June. Throughout the year, we have noted the potential for these positive catalysts and have been positioned in numerous beneficiaries (potential M&A targets, beneficiaries of asset yield repricing, etc.); however, given the swiftness of this move, and the pricing in of much good news, we have trimmed our exposure. While we acknowledge that the momentum may continue, and retain certain positions, we are rotating away some to find more apparent value elsewhere, including US life insurers and European banks.
US lifecos, as we have discussed in past commentaries, are quite analogous to European banks in that 1) they are huge beneficiaries of higher rates, 2) the stocks have been ignored for a decade post GFC, leading to extremely attractive valuations, and 3) balance sheets are very strong and capital return is significant with payout yields generally in the 10-15% range. If there is one takeaway from the policies of the incoming Trump administration, it seems clear that inflation will be on the rise through a combination of fiscal stimulus, a crackdown on immigration, increasing use of tariffs, and plain animal spirits. Indeed, USD market-implied inflation has already made a notable move higher in response to the election results. This is particularly positive for life insurers as higher nominal rates across the curve are supportive of spreads, earnings power, sales, and balance sheet strength. Not surprisingly, US life stocks jumped substantially in response to the election. But they remain remarkably cheap, with PE multiples in the 4-8x range and free cash flow yields well into the double digits despite strong EPS growth supported by buybacks. We continue to build our exposure here opportunistically and suspect a significant rerating could be at hand in the next 12-18 months in this space.
Turning to Europe, the economic implications of Trump’s victory are less clear-cut. The market’s initial reaction was to take a cautious view, with future rate expectations dipping afresh on the outcome (although investment banks rallied on the readacross around deregulation/reigniting animal spirits). Trump’s previous commentary on the European auto industry and the broader topic of tariffs does raise risks for the likes of Germany, where the economy has already been under pressure. On the other hand, if Trump delivers on his promise to end the war in Ukraine, a successful peace deal (beside humanitarian benefits) could provide economic tailwinds via lower energy prices and the investment associated with the country’s rebuild. A more optimistic take is that Trump’s victory could yet galvanise European politicians to pull together to deliver more meaningful integration and economic reform to secure the bloc’s future growth trends. We have rotated away from some of the most rate-sensitive names during 2024 and have previously discussed the attractions of more diversified names like Barclays where certain business lines are better placed for a falling rate environment (investment banking, cards) and where valuations remain undemanding (0.7x P/TNAV). But we highlight that even some of the most rate sensitive names can sustain double-digit returns (and double-digit distribution yields) as rates fall to 2%. Even assuming these rates levels, many European banks still trade at 5-6x ’26. In sum, the risk reward in this space remains attractive with excess capital, strong distributions, hedged balance sheets, and valuations that still sit 30-40% below historical norms both on an absolute and relative basis.
Sustainable Equity Strategy
Global equity markets have been only slightly up in October with some volatility in the market driven by uncertainty on US election, coupled with a bumpy earning season.
Algebris Sustainable World Fund was down 2% in October, bringing YTD return to 9%. The return for the month has been driven by the strong performance of Vertiv (leading AI infrastructure player with sustainable competitive differentiation in data center power and thermal management), Quanta Services (US company that engages in the provision of comprehensive infrastructure solutions to the electric power, oil and gas, communication, pipeline, and energy industries) and Cencora (US diversified healthcare company that provides services in supply chain management, life sciences commercialization, and healthcare technology).
In terms of portfolio activity, we started on EssilorLuxottica, leader in the eyewear market, active in the manufacturing of lenses and frames, and with big growth opportunities coming from the new hearing aid business.
The performance has been driven by our top-down fundamental approach due to a number of reasons. The first being significant EPS acceleration in light of the remarkable resilience of the global economy especially for the ESG themes we play out. Secondly, inflation converging back towards its targets and ability to companies in our portfolio to keep strong gross margins and finally, 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 October: The fund returned between 0.18% and -0.15% across different share classes, compared to EUR HY (BAML HE00 Index) 0.6%, US HY (BAML H0A0 Index) -0.6% and EM sovereign credit (BAML EMGB Index) -2.1%. Performance in October, gross of fees in EUR, was: (i) Credit: -30bps, with -28% from cash bonds and -2bps from CDS; (ii) Rates: 47bps; (iii) FX: 3bps, (iv) Equity: 1bps and (v) Other: 0bps.
What we are doing now: We entered October with low duration and a light net exposure. We warned in September that duration rallies tend to exhaust post first Fed cut and 2024 made no exception. US elections jitters added to pressure on duration.
The outcome of US elections means fixed income will continue to be a difficult market. Republican policies are inflationary and deficit-enhancing, and the vote gives the new administration a strong mandate to carry them out. US inflation breakevens have been on the move, but 80bp of cuts are still priced into 2025. The US curve is still flat from a historical standpoint. Markets aren’t fully pricing yet the impact of Republican policies, setting the stage for more rates volatility in the coming months.
In this environment, we maintain a cautious approach despite the mild repricing in global rates. Our duration is at 2.3y and our net exposure is on the low side of historical range. The bulk of our duration exposure lies in Europe, where implications of the US vote are less bullish.
Credit spreads have been strong so far, but we don’t find credit beta attractive. First, the next leg on UST repricing could put pressure on cash credit, impacting spreads. Second, a trade war is negative for global growth and ultimately for spreads, especially starting from tight valuations. Dispersion in credit markets has reduced over the past three months but remains high, meaning the market still presents opportunities. We maintain a low beta and focus on alpha generation in relatively high-yielding segments of the credit market.
Our blended YTC is 5.6% despite limited net exposure. We run 17% cash allocation and 42% net credit exposure. The Fund is therefore set-up to deliver small but decent returns in a stable market and has plenty of resources to deploy in a market selloff.
More in detail:
Financial Credit Strategy
October proved to be a rather mixed month for risk assets, steered by a combination of elevated geopolitical tensions in the Middle East and the continued refinement in rate cut expectations by the market. The latter featured a consecutive 25bps rate cut by the ECB at their monthly meeting whereas a stronger economic outlook and more robust core CPI readings in the USA pared rate cuts expectations down to under 50bps for the remainder of 2024.
This growing divergence in rate paths was reflected in the performance of financial equities with the SX7E in Europe rising just 0.6% compared to +6.5% for the BKX in the USA, taking the total return year-to-date for both to 30%. In credit, AT1s were largely unchanged with the more senior parts of the capital structure including Tier 2s tightening by 5-10 bps spread-wise.
European banks kicked off their third quarter reporting season pretty much where they left off in the previous quarter. Underlying operating trends remain robust with income across net interest and fees relatively stable and holding up better than expected. Disciplined cost control and lack of deterioration in asset quality are the other two pillars that ensure ongoing capital generation, thereby strengthening the sector further to sequentially better levels. Guidance for the remainder of this year and next year have been either reiterated or upgraded, further proof of the uniqueness of the financial sector vis-à-vis others such as corporates and high yield.
In contrast to Outlook downgrades across some core European countries, there were largely positive rating actions across peripheral European countries as the latter have continued to progressively surprise on a multitude of key fronts including economic growth, fiscal discipline, and political stability. This should bode well for further narrowing of spreads between these two parts especially as investors seek to diversify away from core European exposure given what could be a bumpy few quarters.
October’s primary activity was subdued at just EUR20bn due to the blackout period ahead of third quarter results, the significant pre-funding that has taken place year-to-date, and the increasing geopolitical uncertainty arising from US elections. A few AT1 transactions issued in the month was still met with decent demand by investors as the asset class continues to attract support despite the tighter spreads of the new instruments. Although the issuance calendar for capital instruments should be largely complete this year, we still expect a handful of transactions into year-end as some should opportunistically take advantage of current levels.
Financial Equity Strategy
During October, US banks outperformed a slightly negative S&P 500 with large banks up nearly 7% and smaller peers up 4% as third quarter earnings reports and updated management outlooks were generally better than expected. Bank stocks were buoyed as well by increasing optimism around a potential victory by Donald Trump in the November presidential election. That victory, and a better showing by the Republican party in Congressional races, has indeed come to fruition and the banks have rallied hard as a result. The BKX is up 11% and smaller banks more so in the four days since the election with several factors driving the positive momentum. A more favorable regulatory environment is at the top of the list given that Trump will have the ability to remove the leadership of numerous regulatory agencies in relatively short order. It is expected that new regulatory leaders will be more open to M&A, including at the regional bank level, which would mark a stark contrast from recent years which have seen limited deal activity. Moreover, the Basel III Endgame proposal will likely be meaningfully watered down from its original form, if not scuttled altogether. While it is unclear what a finalized rule may look like, reduced risk-weighted asset inflation could lead to increased capital return over the next several years.
In addition to regulatory relief, the bull case on US banks assumes that Trump’s policies will increase economic growth, leading to higher loan demand along with the continuation of benign credit costs. Lastly, a steeper rate curve should support interest income as lower rate assets roll off into higher yielding loans and securities. While these tailwinds may materialize, it is difficult to discern the magnitude of earnings improvement they will drive. During Trump’s first term, the government’s appetite to cut taxes was clear and the corporate tax rate fell meaningfully from 35% to 21%, leading to over 20% EPS accretion for many banks. Even if the rate is lowered further from 21% to 15% as Trump hopes, but which will likely be very challenging to pass through Congress, this represents a mid-to-high single digit increase to earnings estimates, just a third of the impact of first corporate tax cut. It was also already expected that Basel III would be watered down in some form, so some benefit has been priced in. Before the stock rally post-election, banks had already moved notably higher since the Presidential debate in June, without a matching increase in estimates. As such, the P/E multiple of the BKX using 2026 estimates has increased by nearly 40% on average since mid-June. Throughout the year, we have noted the potential for these positive catalysts and have been positioned in numerous beneficiaries (potential M&A targets, beneficiaries of asset yield repricing, etc.); however, given the swiftness of this move, and the pricing in of much good news, we have trimmed our exposure. While we acknowledge that the momentum may continue, and retain certain positions, we are rotating away some to find more apparent value elsewhere, including US life insurers and European banks.
US lifecos, as we have discussed in past commentaries, are quite analogous to European banks in that 1) they are huge beneficiaries of higher rates, 2) the stocks have been ignored for a decade post GFC, leading to extremely attractive valuations, and 3) balance sheets are very strong and capital return is significant with payout yields generally in the 10-15% range. If there is one takeaway from the policies of the incoming Trump administration, it seems clear that inflation will be on the rise through a combination of fiscal stimulus, a crackdown on immigration, increasing use of tariffs, and plain animal spirits. Indeed, USD market-implied inflation has already made a notable move higher in response to the election results. This is particularly positive for life insurers as higher nominal rates across the curve are supportive of spreads, earnings power, sales, and balance sheet strength. Not surprisingly, US life stocks jumped substantially in response to the election. But they remain remarkably cheap, with PE multiples in the 4-8x range and free cash flow yields well into the double digits despite strong EPS growth supported by buybacks. We continue to build our exposure here opportunistically and suspect a significant rerating could be at hand in the next 12-18 months in this space.
Turning to Europe, the economic implications of Trump’s victory are less clear-cut. The market’s initial reaction was to take a cautious view, with future rate expectations dipping afresh on the outcome (although investment banks rallied on the readacross around deregulation/reigniting animal spirits). Trump’s previous commentary on the European auto industry and the broader topic of tariffs does raise risks for the likes of Germany, where the economy has already been under pressure. On the other hand, if Trump delivers on his promise to end the war in Ukraine, a successful peace deal (beside humanitarian benefits) could provide economic tailwinds via lower energy prices and the investment associated with the country’s rebuild. A more optimistic take is that Trump’s victory could yet galvanise European politicians to pull together to deliver more meaningful integration and economic reform to secure the bloc’s future growth trends. We have rotated away from some of the most rate-sensitive names during 2024 and have previously discussed the attractions of more diversified names like Barclays where certain business lines are better placed for a falling rate environment (investment banking, cards) and where valuations remain undemanding (0.7x P/TNAV). But we highlight that even some of the most rate sensitive names can sustain double-digit returns (and double-digit distribution yields) as rates fall to 2%. Even assuming these rates levels, many European banks still trade at 5-6x ’26. In sum, the risk reward in this space remains attractive with excess capital, strong distributions, hedged balance sheets, and valuations that still sit 30-40% below historical norms both on an absolute and relative basis.
Sustainable Equity Strategy
Global equity markets have been only slightly up in October with some volatility in the market driven by uncertainty on US election, coupled with a bumpy earning season.
Algebris Sustainable World Fund was down 2% in October, bringing YTD return to 9%. The return for the month has been driven by the strong performance of Vertiv (leading AI infrastructure player with sustainable competitive differentiation in data center power and thermal management), Quanta Services (US company that engages in the provision of comprehensive infrastructure solutions to the electric power, oil and gas, communication, pipeline, and energy industries) and Cencora (US diversified healthcare company that provides services in supply chain management, life sciences commercialization, and healthcare technology).
In terms of portfolio activity, we started on EssilorLuxottica, leader in the eyewear market, active in the manufacturing of lenses and frames, and with big growth opportunities coming from the new hearing aid business.
The performance has been driven by our top-down fundamental approach due to a number of reasons. The first being significant EPS acceleration in light of the remarkable resilience of the global economy especially for the ESG themes we play out. Secondly, inflation converging back towards its targets and ability to companies in our portfolio to keep strong gross margins and finally, 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.