How we did in July: The fund returned between 1.46% and 1.16% across different share classes, compared to EUR HY (BAML HE00 Index) 1.3%, US HY (BAML H0A0 Index) 2.0% and EM sovereign credit (BAML EMGB Index) 2.0%. Performance in July, gross of fees in EUR, was: (i) Credit: 1.4%, with 159bps from cash bonds and -23bps from CDS; (ii) Rates: 9bps; (iii) FX: 8bps, (iv) Equity: -1bps and (v) Other: 0bps.
What we are doing now: July saw a broad increase in volatility, as risk assets re-priced a slowdown in global activity and uncertainties stemming from US elections. Soft data kept surprising to the downside, and disappointing earnings triggered a selloff in European and US equity markets. The US Dollar appreciated against Europe and emerging markets, as investors re-assess chances of protectionist US policies, but softened against Asia, as Japanese authorities turned less tolerant on weak currency. Soft data and inflation mean the Fed will start cutting in September. Cuts and anticipation of loose fiscal policies kept the US curve on a steepening trend over the past month.
We continue to maintain a cautious approach on macro. The fund has a high level of protection on risk assets, particularly equities, that helped shield performance in July. The number of cuts priced in global curves is now appropriate if not excessive, and fiscal risks persist, hence we maintain a moderate degree of duration. We reduced conviction on stronger yen and reduced exposure to EM FX.
We continue to see selected opportunities in credit but do not rush to add risk, as valuations remain tight and macro vol is on the rise. Tight spreads and high all-in yields mean we only need to sacrifice a moderate portion of our yield to own volatility. We currently give up ~70bps of yield to more than halve our net credit exposure, a trade-off which we consider attractive. Our blended YTC is 6%.
We run record cash levels of ~18%. Over the past six weeks, we reduced exposure to areas with higher beta (Financials and EM), to re-allocate to corporates.
More in detail:
The Fund blended YTC is 6%, with average rating of BBB-.
The Fund duration is now 3y, close to the average of our two-year range. We hold steepeners on the US curve.
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 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 32% of the book. We focus on high 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 11% of the book. We have cut some risk in June and look to re-engage on a stabilization of vol. EM local is now 4% of the fund.
Financial Credit Strategy
July started on a positive note for risk assets. In France, an unexpected outcome in the second round of elections reassured markets that neither extreme party’s programs would likely be implemented, whilst in the US, a weaker than expected CPI report increased chances for FED rate cuts, with Bank of Canada and England already following through with cuts in July. However, by mid-July concerns started rising around softening macroeconomic data, which combined with weaker than expected tech-sector results and a more hawkish tone from the Bank of Japan, made markets more challenging.
In this context, Banks performance remained strong across the capital structure. In the equity space, banks were a standout sector with Europe +6% (YTD +28%), US +10% (YTD +22%) and US regionals +19% (YTD +13%). On the credit side, spreads across European banks were largely unchanged and AT1s rallied 2pts in sympathy with rates c30bps tighter across core and periphery curves, in part helped by the positive technical which has seen very few primary deals vis-à-vis the size of the asset class.
July was busy with European banks reporting results for their half year performance which once more showed improving fundamentals and, to some extent, outlook. Pre-tax profits rose +6% YoY in the quarter and were broadly ahead of consensus due to materially lower than expect loan loss provisions reflecting the benign asset quality. Revenue growth remained largely stable (c1% YoY) across both net interest income and fees, and cost reduction measures contributed to the bottom line too. Capital accretion led to sequentially stronger positions, on average +10bps QoQ. This is after accruing for the ongoing reach distribution programs decided by management such as Standard Charted and HSBC announcing higher than expected buyback worth $1.5bn and $3bn respectively. Unsurprisingly positive ratings actions continued across the sector in July and were focused mainly in the periphery where some entities got an inaugural investment grade rating.
As in previous July’s, primary activity was subdued due to the start of the second quarter results reporting season, though this year heightened macroeconomic uncertainties contributed further to the lack of new issuance. Of the EUR15bn that was issued, around 50% and 90% were in secured and senior format, respectively. There were only a few capital transactions mainly in the AT1 format which gathered quite decent demand from investors (books were on average over 6x covered).
Although funding (and capital) plans for European banks are largely completed, there remains a few pockets of needs that we expect to be filled over the coming months. This, combined with the defensive nature of the fund’s positioning from a cash perspective, leaves it in a prime position to take advantage of any exaggerated dislocations.
Financial Equity Strategy
The global financial sector delivered another solid month of outperformance in July (c.3%, in light of good 2Q reporting) until the decision by the Bank of Japan to hike rates followed swiftly by weaker employment data in the US sparked fresh market questions about the future direction of interest rates and the broader economic outlook. The sector corrected by >7% in the first 3 trading days of August (albeit underperforming the broader index by only 1%). We see this as an opportunity.
European banks remain our preferred exposure. While questions around the pace of rate cuts and momentum in the economy are valid, we struggle to see fundamental justifications for this sell off. Re-running our stress test scenario we can see that applying pre-COVID margins (i.e. pre any rate hikes) and applying COVID-level provisions (i.e. recession scenario) the adjusted earnings would leave the sector trading on c.9.5x 2026 earnings (vs current <6.5x consensus). In other words, even on highly stressed scenarios, the stocks still trade below their long-run average multiple of 10x. We also take comfort in the strong defenses many European banks have in a falling rate environment. Banks like Barclays in the UK have large structural hedge positions which smooth net interest income over time and will effectively ‘pay out’ as interest rates come down. Barclays’ hedge size is equivalent to one third of its deposit base and the mechanical rollover is expected to contribute cumulative incremental income equivalent to almost 20% of PBT over 2025-26. Meanwhile Barclays diversification is an additional strength with the investment bank (>40% revenues) and US consumer business (c.13% revenues) expected to be relative beneficiaries of lower rates given the associated positive connotations for activity levels and asset quality/demand levels respectively. Our base line remains that rates can settle in the 2-3% range and in that environment, we think the European banks look well placed.
Meanwhile Japanese banks suffered the steepest correction in the sell-off (>15% vs pre BoJ rate hike levels), but where the investment merits remain less clear-cut in our view. Despite the de-rating, Japanese banks still trade on c.9x P/E, implying you need to assume either higher rate hikes or more favorable deposit pricing dynamics than assumed by consensus to land at a more compelling valuation. We think the jury remains out on both those dynamics, particularly if faster rate cuts by other central banks play out. With Japanese banks offering a yield of c.5% compared to c.12% (including buybacks) in Europe, we continue to see better risk/reward at the latter.
Global Credit Strategy
How we did in July: The fund returned between 1.46% and 1.16% across different share classes, compared to EUR HY (BAML HE00 Index) 1.3%, US HY (BAML H0A0 Index) 2.0% and EM sovereign credit (BAML EMGB Index) 2.0%. Performance in July, gross of fees in EUR, was: (i) Credit: 1.4%, with 159bps from cash bonds and -23bps from CDS; (ii) Rates: 9bps; (iii) FX: 8bps, (iv) Equity: -1bps and (v) Other: 0bps.
What we are doing now: July saw a broad increase in volatility, as risk assets re-priced a slowdown in global activity and uncertainties stemming from US elections. Soft data kept surprising to the downside, and disappointing earnings triggered a selloff in European and US equity markets. The US Dollar appreciated against Europe and emerging markets, as investors re-assess chances of protectionist US policies, but softened against Asia, as Japanese authorities turned less tolerant on weak currency. Soft data and inflation mean the Fed will start cutting in September. Cuts and anticipation of loose fiscal policies kept the US curve on a steepening trend over the past month.
We continue to maintain a cautious approach on macro. The fund has a high level of protection on risk assets, particularly equities, that helped shield performance in July. The number of cuts priced in global curves is now appropriate if not excessive, and fiscal risks persist, hence we maintain a moderate degree of duration. We reduced conviction on stronger yen and reduced exposure to EM FX.
We continue to see selected opportunities in credit but do not rush to add risk, as valuations remain tight and macro vol is on the rise. Tight spreads and high all-in yields mean we only need to sacrifice a moderate portion of our yield to own volatility. We currently give up ~70bps of yield to more than halve our net credit exposure, a trade-off which we consider attractive. Our blended YTC is 6%.
We run record cash levels of ~18%. Over the past six weeks, we reduced exposure to areas with higher beta (Financials and EM), to re-allocate to corporates.
More in detail:
Financial Credit Strategy
July started on a positive note for risk assets. In France, an unexpected outcome in the second round of elections reassured markets that neither extreme party’s programs would likely be implemented, whilst in the US, a weaker than expected CPI report increased chances for FED rate cuts, with Bank of Canada and England already following through with cuts in July. However, by mid-July concerns started rising around softening macroeconomic data, which combined with weaker than expected tech-sector results and a more hawkish tone from the Bank of Japan, made markets more challenging.
In this context, Banks performance remained strong across the capital structure. In the equity space, banks were a standout sector with Europe +6% (YTD +28%), US +10% (YTD +22%) and US regionals +19% (YTD +13%). On the credit side, spreads across European banks were largely unchanged and AT1s rallied 2pts in sympathy with rates c30bps tighter across core and periphery curves, in part helped by the positive technical which has seen very few primary deals vis-à-vis the size of the asset class.
July was busy with European banks reporting results for their half year performance which once more showed improving fundamentals and, to some extent, outlook. Pre-tax profits rose +6% YoY in the quarter and were broadly ahead of consensus due to materially lower than expect loan loss provisions reflecting the benign asset quality. Revenue growth remained largely stable (c1% YoY) across both net interest income and fees, and cost reduction measures contributed to the bottom line too. Capital accretion led to sequentially stronger positions, on average +10bps QoQ. This is after accruing for the ongoing reach distribution programs decided by management such as Standard Charted and HSBC announcing higher than expected buyback worth $1.5bn and $3bn respectively. Unsurprisingly positive ratings actions continued across the sector in July and were focused mainly in the periphery where some entities got an inaugural investment grade rating.
As in previous July’s, primary activity was subdued due to the start of the second quarter results reporting season, though this year heightened macroeconomic uncertainties contributed further to the lack of new issuance. Of the EUR15bn that was issued, around 50% and 90% were in secured and senior format, respectively. There were only a few capital transactions mainly in the AT1 format which gathered quite decent demand from investors (books were on average over 6x covered).
Although funding (and capital) plans for European banks are largely completed, there remains a few pockets of needs that we expect to be filled over the coming months. This, combined with the defensive nature of the fund’s positioning from a cash perspective, leaves it in a prime position to take advantage of any exaggerated dislocations.
Financial Equity Strategy
The global financial sector delivered another solid month of outperformance in July (c.3%, in light of good 2Q reporting) until the decision by the Bank of Japan to hike rates followed swiftly by weaker employment data in the US sparked fresh market questions about the future direction of interest rates and the broader economic outlook. The sector corrected by >7% in the first 3 trading days of August (albeit underperforming the broader index by only 1%). We see this as an opportunity.
European banks remain our preferred exposure. While questions around the pace of rate cuts and momentum in the economy are valid, we struggle to see fundamental justifications for this sell off. Re-running our stress test scenario we can see that applying pre-COVID margins (i.e. pre any rate hikes) and applying COVID-level provisions (i.e. recession scenario) the adjusted earnings would leave the sector trading on c.9.5x 2026 earnings (vs current <6.5x consensus). In other words, even on highly stressed scenarios, the stocks still trade below their long-run average multiple of 10x. We also take comfort in the strong defenses many European banks have in a falling rate environment. Banks like Barclays in the UK have large structural hedge positions which smooth net interest income over time and will effectively ‘pay out’ as interest rates come down. Barclays’ hedge size is equivalent to one third of its deposit base and the mechanical rollover is expected to contribute cumulative incremental income equivalent to almost 20% of PBT over 2025-26. Meanwhile Barclays diversification is an additional strength with the investment bank (>40% revenues) and US consumer business (c.13% revenues) expected to be relative beneficiaries of lower rates given the associated positive connotations for activity levels and asset quality/demand levels respectively. Our base line remains that rates can settle in the 2-3% range and in that environment, we think the European banks look well placed.
Meanwhile Japanese banks suffered the steepest correction in the sell-off (>15% vs pre BoJ rate hike levels), but where the investment merits remain less clear-cut in our view. Despite the de-rating, Japanese banks still trade on c.9x P/E, implying you need to assume either higher rate hikes or more favorable deposit pricing dynamics than assumed by consensus to land at a more compelling valuation. We think the jury remains out on both those dynamics, particularly if faster rate cuts by other central banks play out. With Japanese banks offering a yield of c.5% compared to c.12% (including buybacks) in Europe, we continue to see better risk/reward at the latter.