How we did in April: The fund returned between –0.50% and -0.62% across different share classes, compared to EUR HY (BAML HE00 Index) 0%, US HY (BAML H0A0 Index) -1.0% and EM sovereign credit (BAML EMGB Index) -2.0%. Performance in April, gross of fees in EUR, was: (i) Credit: -1.1%, with -1.2% from cash bonds and 12bps from CDS; (ii) Rates: 12bps; (iii) FX: -3bps, (iv) Hedges: 40bps and (v) Other: 0bps.
What we are doing now: April was characterized by a pick-up in inflation fears. Stronger than expected US inflation data triggered a meaningful re-pricing in US treasury, with the curve up broadly 40bp over the month, and currently just shy of October levels. The Fed has changed tone to signal less immediate cuts, legitimating the price action. Price action in US rates spilled over to global rates, including regions where cuts are more likely near term, such as Europe and selected emerging markets.
Volatility picked up in credit spreads, but the 50bp widening in HY spreads seen in the first half of the month reverted as markets re-assessed potential tail risks from the ongoing Middle-East crisis. Selected credit events raised market attention on tail risks in credit.
We continue to run risk on the cautious side vs the past two-year range. Our net credit exposure is now below 50%, duration is 2.7y, and our cash levels stand at c.15%. As we highlighted in our February Algebris Bullet, markets started the year too bullish on both rates and credit. Now rates seem more balanced, while credit spreads remain vulnerable.
The pick-up in macro and credit volatility over the past quarter makes the December dovish turn from the Fed look like a distant memory. We see the ongoing repricing as a reminder to fixed income investors that the macro volatility that picked up in 2022 is here to stay, increasing the value of a flexible approach to duration and credit.
More in detail:
The Fund blended YTC is 7.3%, with average rating BBB-.
The Fund duration is now 2.7, substantially lower than in late October. We see central bank pricing for 2024 appropriate but hold steepeners given strength in US data. We see value emerging in 2-5y segments of global curves and look to gradually re-engage in duration extension.
Our net credit exposure is 42%. We currently run 15% cash, and hold protection via US IG and HY spreads, European HY spreads and EM spreads. The protection has low carry cost thanks to tight spread hence our net YTC is little impacted.
Net exposure in financials (incl. cash short and single name CDS) represents 32% of the book. AT1 and financial subordinated was a key trade in 2023, and subordinated risk re-priced meaningfully in the past year. 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 28% of the book. We focus on 8-10% 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 14% of the book. We maintain a balanced focus on hard and local currency but look to gradually increase the latter as valuations are turning dislocated as a result of the price action in US Treasuries.
Financial Credit Strategy
After the strong start so far this year, April was a mixed month for risk assets. In a backdrop of heightened geopolitical tension between Iran and Israel, a series of hawkish economic datapoints in the USA strengthened the notion of “higher for longer”. Expectations of rate cuts by the FED were pushed out further again and reduced to just one by year end, which drove in part the corresponding 50bp increase in the US 10Y. Equity indices broke their streak of monthly gains with the S&P500 and STOXX 600 retracing -4.1% and -0.8% respectively whereas European financials notched up another month of outperformance, +4.4% for the broader SX7P European financials taking the YTD to c20%. Across credit, AT1s consolidated after strong outperformance this year in response to higher rates albeit remaining in high demand.
The start of first quarter earnings seasons for European banks highlighted ongoing improvement in fundamentals, albeit at a slower pace compared to last year as higher rates have started to get priced in making comparisons harder. Most banks beat profit expectations on a mix of higher revenues, moderate cost inflation and lower loan loss provisions. Asset quality remains resilient, with the stock of impaired loans largely unchanged over the quarter and some banks retaining a substantial unused stock of overlay provisions as a buffer to potential future deterioration. With capital ratios up c.10bps QoQ from what already are very solid levels, banks broadly confirmed their initial distribution targets. In this context, rating agencies continue to play catch-up with further outlook upgrades (e.g. Caixa, Sabadell, Commerzbank) and most notably S&P announced that it will rate Santander AT1s Investment Grade at BBB-.
European Bank M&A has come back into focus in recent weeks with two smaller deals announced in the UK (Coventry/Coop & Nationwide/Virgin Money) and BBVA launching an unsolicited bid for Sabadell in Spain last week (somewhat out of the blue, but not entirely surprising given preceding talks between the two in 2020 which broke down). The nature of regulation in the Eurozone still detracts from some of the potential attractions of larger-scale cross-border M&A, but deploying capital into ‘in-market’ deals can make a lot of sense in our view.
The synergies achievable in prior M&A deals in southern Europe have typically amounted to c.40% of the acquired cost-base which can deliver attractive earnings accretion. Although such savings come at an upfront cost, the recovery in valuations leaves some banks with a more powerful ‘currency’ with which to pursue deals vs other lower-valued peers. If done at the right price, such deals can add to the distribution capacity of banks over the medium-term. We believe consolidation will remain a theme going forward, particularly as the easy-win of higher rates fades and we see more differentiated profit performance across individual banks.
Primary activity in April was subdued at just EUR15bn as financial entities had already pre-funded a significant amount of this year’s requirements in 1Q24 (EUR185bn), uncertainty crept in around the magnitude and timing of rate cuts, and impending 1Q24 results’ announcements capped the available issuance windows. A wave of AT1 calls in April meant that around 70% of this year’s securities up for refinancing have already been dealt with, reinforcing the very strong technical position the AT1 market finds itself in. Issuance should pick-up in May and June, providing ample decent investment opportunities for our funds.
Financial Equity Strategy
The fund outperformed in April, led by European banks as the overall index was down over 2% for the month. It was yet another solid earnings season for banks in Europe, with aggregate profits beating consensus by ~8%, with beats across the revenue, cost, and provision line. Importantly, forward estimates continue to march higher, in sharp contrast to many investors’ views at the beginning of this year. The stocks remain undeniably cheap and earnings keep going up – in our view, European bank equities still look very attractive even after a strong 2023 and a nice start to this year.
The most exciting story in European banks is not earnings, however, but rather a surprising return of open bank M&A. In recent weeks we have seen 1) two smaller deals announced in the UK (Coventry/Coop & Nationwide/Virgin Money) and 2) BBVA launching an unsolicited bid for Sabadell in Spain last week (somewhat out of the blue, but not entirely surprising given preceding talks between the two in 2020 which ultimately broke down). Moreover Sabadell has been an important positive contributor for the fund for some time.
The nature of regulation in the Eurozone still detracts from some of the potential attractions of larger-scale cross-border M&A, but deploying capital into ‘in-market’ deals can make a lot of sense in our view. The synergies achievable in prior deals in southern Europe have typically amounted to ~40% of the acquired cost-base which can deliver attractive earnings accretion and although such savings come at an upfront cost, the recovery in valuations leaves some banks with a more powerful ‘currency’ with which to pursue deals vs other lower-valued peers. If done at the right price, such deals can add to the distribution capacity of banks over the medium-term. We believe consolidation will remain a theme going forward, particularly as the easy-win of higher rates fades and we see more differentiated profit performance across individual banks.
Similarly in the US, merger announcements among smaller banks has picked up in recent weeks and could be a sign of things to come, especially as the need for scale and efficiency becomes more apparent. This nascent activity could also be meaningfully strengthened if the regulatory environment becomes more favorable under a Republican administration. After a long hiatus from bank M&A in both the US and Europe, the ingredients are in place for activity to return in the next 12-24 months and we certainly expect to be on the hunt for winners in this new market regime, whether it be via smart acquirers or takeout candidates on either side of the Atlantic.
Global Credit Strategy
How we did in April: The fund returned between –0.50% and -0.62% across different share classes, compared to EUR HY (BAML HE00 Index) 0%, US HY (BAML H0A0 Index) -1.0% and EM sovereign credit (BAML EMGB Index) -2.0%. Performance in April, gross of fees in EUR, was: (i) Credit: -1.1%, with -1.2% from cash bonds and 12bps from CDS; (ii) Rates: 12bps; (iii) FX: -3bps, (iv) Hedges: 40bps and (v) Other: 0bps.
What we are doing now: April was characterized by a pick-up in inflation fears. Stronger than expected US inflation data triggered a meaningful re-pricing in US treasury, with the curve up broadly 40bp over the month, and currently just shy of October levels. The Fed has changed tone to signal less immediate cuts, legitimating the price action. Price action in US rates spilled over to global rates, including regions where cuts are more likely near term, such as Europe and selected emerging markets.
Volatility picked up in credit spreads, but the 50bp widening in HY spreads seen in the first half of the month reverted as markets re-assessed potential tail risks from the ongoing Middle-East crisis. Selected credit events raised market attention on tail risks in credit.
We continue to run risk on the cautious side vs the past two-year range. Our net credit exposure is now below 50%, duration is 2.7y, and our cash levels stand at c.15%. As we highlighted in our February Algebris Bullet, markets started the year too bullish on both rates and credit. Now rates seem more balanced, while credit spreads remain vulnerable.
The pick-up in macro and credit volatility over the past quarter makes the December dovish turn from the Fed look like a distant memory. We see the ongoing repricing as a reminder to fixed income investors that the macro volatility that picked up in 2022 is here to stay, increasing the value of a flexible approach to duration and credit.
More in detail:
Financial Credit Strategy
After the strong start so far this year, April was a mixed month for risk assets. In a backdrop of heightened geopolitical tension between Iran and Israel, a series of hawkish economic datapoints in the USA strengthened the notion of “higher for longer”. Expectations of rate cuts by the FED were pushed out further again and reduced to just one by year end, which drove in part the corresponding 50bp increase in the US 10Y. Equity indices broke their streak of monthly gains with the S&P500 and STOXX 600 retracing -4.1% and -0.8% respectively whereas European financials notched up another month of outperformance, +4.4% for the broader SX7P European financials taking the YTD to c20%. Across credit, AT1s consolidated after strong outperformance this year in response to higher rates albeit remaining in high demand.
The start of first quarter earnings seasons for European banks highlighted ongoing improvement in fundamentals, albeit at a slower pace compared to last year as higher rates have started to get priced in making comparisons harder. Most banks beat profit expectations on a mix of higher revenues, moderate cost inflation and lower loan loss provisions. Asset quality remains resilient, with the stock of impaired loans largely unchanged over the quarter and some banks retaining a substantial unused stock of overlay provisions as a buffer to potential future deterioration. With capital ratios up c.10bps QoQ from what already are very solid levels, banks broadly confirmed their initial distribution targets. In this context, rating agencies continue to play catch-up with further outlook upgrades (e.g. Caixa, Sabadell, Commerzbank) and most notably S&P announced that it will rate Santander AT1s Investment Grade at BBB-.
European Bank M&A has come back into focus in recent weeks with two smaller deals announced in the UK (Coventry/Coop & Nationwide/Virgin Money) and BBVA launching an unsolicited bid for Sabadell in Spain last week (somewhat out of the blue, but not entirely surprising given preceding talks between the two in 2020 which broke down). The nature of regulation in the Eurozone still detracts from some of the potential attractions of larger-scale cross-border M&A, but deploying capital into ‘in-market’ deals can make a lot of sense in our view.
The synergies achievable in prior M&A deals in southern Europe have typically amounted to c.40% of the acquired cost-base which can deliver attractive earnings accretion. Although such savings come at an upfront cost, the recovery in valuations leaves some banks with a more powerful ‘currency’ with which to pursue deals vs other lower-valued peers. If done at the right price, such deals can add to the distribution capacity of banks over the medium-term. We believe consolidation will remain a theme going forward, particularly as the easy-win of higher rates fades and we see more differentiated profit performance across individual banks.
Primary activity in April was subdued at just EUR15bn as financial entities had already pre-funded a significant amount of this year’s requirements in 1Q24 (EUR185bn), uncertainty crept in around the magnitude and timing of rate cuts, and impending 1Q24 results’ announcements capped the available issuance windows. A wave of AT1 calls in April meant that around 70% of this year’s securities up for refinancing have already been dealt with, reinforcing the very strong technical position the AT1 market finds itself in. Issuance should pick-up in May and June, providing ample decent investment opportunities for our funds.
Financial Equity Strategy
The fund outperformed in April, led by European banks as the overall index was down over 2% for the month. It was yet another solid earnings season for banks in Europe, with aggregate profits beating consensus by ~8%, with beats across the revenue, cost, and provision line. Importantly, forward estimates continue to march higher, in sharp contrast to many investors’ views at the beginning of this year. The stocks remain undeniably cheap and earnings keep going up – in our view, European bank equities still look very attractive even after a strong 2023 and a nice start to this year.
The most exciting story in European banks is not earnings, however, but rather a surprising return of open bank M&A. In recent weeks we have seen 1) two smaller deals announced in the UK (Coventry/Coop & Nationwide/Virgin Money) and 2) BBVA launching an unsolicited bid for Sabadell in Spain last week (somewhat out of the blue, but not entirely surprising given preceding talks between the two in 2020 which ultimately broke down). Moreover Sabadell has been an important positive contributor for the fund for some time.
The nature of regulation in the Eurozone still detracts from some of the potential attractions of larger-scale cross-border M&A, but deploying capital into ‘in-market’ deals can make a lot of sense in our view. The synergies achievable in prior deals in southern Europe have typically amounted to ~40% of the acquired cost-base which can deliver attractive earnings accretion and although such savings come at an upfront cost, the recovery in valuations leaves some banks with a more powerful ‘currency’ with which to pursue deals vs other lower-valued peers. If done at the right price, such deals can add to the distribution capacity of banks over the medium-term. We believe consolidation will remain a theme going forward, particularly as the easy-win of higher rates fades and we see more differentiated profit performance across individual banks.
Similarly in the US, merger announcements among smaller banks has picked up in recent weeks and could be a sign of things to come, especially as the need for scale and efficiency becomes more apparent. This nascent activity could also be meaningfully strengthened if the regulatory environment becomes more favorable under a Republican administration. After a long hiatus from bank M&A in both the US and Europe, the ingredients are in place for activity to return in the next 12-24 months and we certainly expect to be on the hunt for winners in this new market regime, whether it be via smart acquirers or takeout candidates on either side of the Atlantic.