In 2022, the fund returned between -4% and 0% across share classes, significantly outperforming credit indices: EUR HY (BAML HE00 Index) -11.5%, US HY (BAML H0A0 Index) -11.2% and EM sovereign credit (BAML EMGB Index) -18.8%
How we did in December: The fund returned between 0.2% and 0.5% across the different share classes, compared to EUR HY (BAML HE00 Index) -0.8%, US HY (BAML H0A0 Index) -0.8% and EM sovereign credit (BAML EMGB Index) 0.7%. Performance in December, gross of fees in EUR, was: (i) Credit: -22bps, with -22bps from cash and 0bps from CDS; (ii) Rates: 72bps; (iii) FX: 7bps, (iv) Equity: -6bps and (v) Other: -1bps.
December marked a soft end to 2022. Inflation fears and hawkish comments from European and US central banks led to a drop in equities and interest rates trending higher. The Bank of Japan, in a surprise move, announced it would change its yield curve control policy.
What are we doing now: The fund continues to be long credit and has added duration recently. In credit, the focus remains on high grade bonds.
The fund is 80% net invested in credit and has a total duration of 2.3. The Fund’s blended YTM is 6.9%.
Credit remains cheap, especially in certain pockets of the Investment Grade market and Financials.
2023 will be a year of moderate slowdown and disinflation in developed markets. Interest rates will be more stable as a result.
The fund covered a number of shorts that played out in the last six months
Net credit investment was raised in July, and remain broadly stable at its highest level in December.
Fund duration is close to its highest levels in 2022 (having been close to 0 earlier in the year).
We continue to focus on quality credit, in anticipation of more dispersion in prices in 2023, as higher levered issuers bear the brunt of higher interest rates.
On the cash credit book, we therefore focus on quality, low leverage names across credit asset classes, with bonds yielding 6-8%, 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 added some longs in EM rates, Investment Grade European Residential and Aircraft Lessor bonds.
Shorts focus on the consumer and commercial real estate sectors in Europe and countries with high refinancing needs in EM.
Gross exposure in the fund is 135%. The credit short book is 24%, of which 15% in cash credit and 9% in CDS.
Financial Credit Strategy
Following the rally in risk assets over the previous two months, December turned out to be more subdued as the focus returned to central banks (CB). With inflation showing tentative and encouraging signs of peaking, both the Fed and the ECB expectedly stepped down to 50bps rate hikes at their respective meetings. That said, both reiterated their hawkish stance with respect to further rate increases in 2023 being needed to tame inflationary expectations. The ECB stood out by signalling that interest rates would need to rise more than initially expected “for a period of time” despite initial macroeconomic signals that activity is slowing.
This CB rhetoric inevitably tempered the tone in risk appetite. Across sovereign rates, curves broadly parallel shifted upwards – core and periphery by 30bps and 70bps, respectively – along with a 15bps steepening in 2s10s. Global equity indices ended December 5% lower on average, increasing YTD losses to 11% on average; US indices were the clear underperformers -7% MoM and -23% YTD.
As had been largely the case throughout 2022, European Financials equities were once again the standout sector, ending December +1% and posting 2% YTD gains. Across the capital structure, AT1s rallied 50c with spread-based Seniors and Subordinated 5-15bps tighter despite the move wider in rates, the heavy primary activity in November and what should be another busy January from an issuance perspective.
The most noteworthy event in December for European Financials was the decision by UBS to call an existing AT1 that had the lowest reset rate across the entire asset class. Although one could have argued that it was economic to leave outstanding given the perpetual reset rate of 243bps over US 5y swaps, the holistic decision to consider the overall future cost implications to the entire capital structure meant the security was surplus to requirements. This subsequently prompted a rally in the asset class as concerns over other potential extensions dissipated.
As part of the second TLTRO repayment window of the three, European banks repaid close to EUR450bn in early December. This far exceeded market expectations of EUR330bn as banks took a more active stance on balance sheet optimisation ahead of year-end of reporting. Combined with a further EUR52bn of maturing TLTRO borrowings in December, the remaining TLTRO balance is now EUR1.3tn of which roughly half matures in June 2023.
After what was the biggest issuance month on record in November, December turned out to be one of the smallest at EUR8bn which included just a few capital transactions. Overall, 2022 was one of the most active with around EUR450bn issued, a 40% increase on the prior three years’ average driven by Seniors +50% as the issuance of capital instruments was broadly unchanged. We expect these trends to be broadly similar in 2023 which should once again provide attractive investment opportunities for our funds.
Financial Equity Strategy
Despite a difficult 2022 that included war, inflation, economic slowdown, dreadful bond and equity markets, the global financial sector (MSCI AC Financials) outperformed, finishing the year down just over 9% while the broad global market (MSCI AC) was down roughly twice that. Within the sector, US banks were down a hefty 21% while European banks eked out a 2% gain. The Fund went one step further and was up ~8% for the year. Most of the performance came from our European bank sector holdings, but positive contributions came from the US as well as Asia. The interest rate hikes of late 2022 transformed banks’ deposit franchises to being highly profitably, with the bulk of the benefits still largely ahead of us.
The fear of recession became universal in H2 2022 and the European banks front loaded provisions throughout the year, on top of sitting on substantial unused Covid provisions. With gas prices falling to pre-war levels, we expect GDP revisions to begin to stabilize and trough in Europe in H1 2023. The economic outlook is set to improve by mid-year and with valuations close to decade lows, strong cash distributions and earnings upgrades coming through despite higher provisions, the bank sector is likely to continue to see strong performance in 2023 and 2024.
December saw a microcosm of the above. Fear of recession dominated markets and the Fund was down slightly. We took advantage of this to buy some beaten up stocks in the US. European banks were able to buck the overall trend as exhausted and fearful sellers were met by continuous earnings upgrades. We expect the earnings upgrades battle to win out by the end of 2023, but economic weakness is likely to keep markets jittery for a number of months. Overall, we believe the European bank sector could grind its way back to 2018 levels over the coming quarters, providing an attractive opportunity for investors. And before concluding we are getting overly bullish, please note that in 2018, European banks did not have excess capital, there was no rate tailwind to speak of, profitability was notably weaker, and earnings upgrades were few and far between. Quite the contrast from today!
Global credit strategy
In 2022, the fund returned between -4% and 0% across share classes, significantly outperforming credit indices: EUR HY (BAML HE00 Index) -11.5%, US HY (BAML H0A0 Index) -11.2% and EM sovereign credit (BAML EMGB Index) -18.8%
How we did in December: The fund returned between 0.2% and 0.5% across the different share classes, compared to EUR HY (BAML HE00 Index) -0.8%, US HY (BAML H0A0 Index) -0.8% and EM sovereign credit (BAML EMGB Index) 0.7%. Performance in December, gross of fees in EUR, was: (i) Credit: -22bps, with -22bps from cash and 0bps from CDS; (ii) Rates: 72bps; (iii) FX: 7bps, (iv) Equity: -6bps and (v) Other: -1bps.
December marked a soft end to 2022. Inflation fears and hawkish comments from European and US central banks led to a drop in equities and interest rates trending higher. The Bank of Japan, in a surprise move, announced it would change its yield curve control policy.
What are we doing now: The fund continues to be long credit and has added duration recently. In credit, the focus remains on high grade bonds.
Financial Credit Strategy
Following the rally in risk assets over the previous two months, December turned out to be more subdued as the focus returned to central banks (CB). With inflation showing tentative and encouraging signs of peaking, both the Fed and the ECB expectedly stepped down to 50bps rate hikes at their respective meetings. That said, both reiterated their hawkish stance with respect to further rate increases in 2023 being needed to tame inflationary expectations. The ECB stood out by signalling that interest rates would need to rise more than initially expected “for a period of time” despite initial macroeconomic signals that activity is slowing.
This CB rhetoric inevitably tempered the tone in risk appetite. Across sovereign rates, curves broadly parallel shifted upwards – core and periphery by 30bps and 70bps, respectively – along with a 15bps steepening in 2s10s. Global equity indices ended December 5% lower on average, increasing YTD losses to 11% on average; US indices were the clear underperformers -7% MoM and -23% YTD.
As had been largely the case throughout 2022, European Financials equities were once again the standout sector, ending December +1% and posting 2% YTD gains. Across the capital structure, AT1s rallied 50c with spread-based Seniors and Subordinated 5-15bps tighter despite the move wider in rates, the heavy primary activity in November and what should be another busy January from an issuance perspective.
The most noteworthy event in December for European Financials was the decision by UBS to call an existing AT1 that had the lowest reset rate across the entire asset class. Although one could have argued that it was economic to leave outstanding given the perpetual reset rate of 243bps over US 5y swaps, the holistic decision to consider the overall future cost implications to the entire capital structure meant the security was surplus to requirements. This subsequently prompted a rally in the asset class as concerns over other potential extensions dissipated.
As part of the second TLTRO repayment window of the three, European banks repaid close to EUR450bn in early December. This far exceeded market expectations of EUR330bn as banks took a more active stance on balance sheet optimisation ahead of year-end of reporting. Combined with a further EUR52bn of maturing TLTRO borrowings in December, the remaining TLTRO balance is now EUR1.3tn of which roughly half matures in June 2023.
After what was the biggest issuance month on record in November, December turned out to be one of the smallest at EUR8bn which included just a few capital transactions. Overall, 2022 was one of the most active with around EUR450bn issued, a 40% increase on the prior three years’ average driven by Seniors +50% as the issuance of capital instruments was broadly unchanged. We expect these trends to be broadly similar in 2023 which should once again provide attractive investment opportunities for our funds.
Financial Equity Strategy
Despite a difficult 2022 that included war, inflation, economic slowdown, dreadful bond and equity markets, the global financial sector (MSCI AC Financials) outperformed, finishing the year down just over 9% while the broad global market (MSCI AC) was down roughly twice that. Within the sector, US banks were down a hefty 21% while European banks eked out a 2% gain. The Fund went one step further and was up ~8% for the year. Most of the performance came from our European bank sector holdings, but positive contributions came from the US as well as Asia. The interest rate hikes of late 2022 transformed banks’ deposit franchises to being highly profitably, with the bulk of the benefits still largely ahead of us.
The fear of recession became universal in H2 2022 and the European banks front loaded provisions throughout the year, on top of sitting on substantial unused Covid provisions. With gas prices falling to pre-war levels, we expect GDP revisions to begin to stabilize and trough in Europe in H1 2023. The economic outlook is set to improve by mid-year and with valuations close to decade lows, strong cash distributions and earnings upgrades coming through despite higher provisions, the bank sector is likely to continue to see strong performance in 2023 and 2024.
December saw a microcosm of the above. Fear of recession dominated markets and the Fund was down slightly. We took advantage of this to buy some beaten up stocks in the US. European banks were able to buck the overall trend as exhausted and fearful sellers were met by continuous earnings upgrades. We expect the earnings upgrades battle to win out by the end of 2023, but economic weakness is likely to keep markets jittery for a number of months. Overall, we believe the European bank sector could grind its way back to 2018 levels over the coming quarters, providing an attractive opportunity for investors. And before concluding we are getting overly bullish, please note that in 2018, European banks did not have excess capital, there was no rate tailwind to speak of, profitability was notably weaker, and earnings upgrades were few and far between. Quite the contrast from today!