How we did in December: The fund returned between 1.03% and 0.62% across different share classes, while EUR HY (BAML HE00 Index) returned 0.6%, US HY (BAML H0A0 Index) -0.4% and EM sovereign credit (BAML EMGB Index) -1.7%. Performance in December, gross of fees in EUR, was: (i) Credit: 48bps, with 40bps from cash bonds and 8bps from CDS; (ii) Rates: 19bps; (iii) FX: 6bps, (iv) Equity: 46bps and (v) Other: 0bps.
What we are doing now: Global risk enters 2025 with tight valuations and long positioning across asset classes. Credit spreads are close to 2021 tights and cash levels are low despite sustained inflows. A pickup in rates volatility or an equity market correction may thus hurt credit, particularly given the negatively asymmetric starting point.
The risk-reward in US rates is more balanced than a month ago as the hawkish December FOMC removed the bulk of 2025 cuts from the curve. However, the US curve is still flat by historical standards and is gradually steepening out the five-year point. US policy noise around the new administration inauguration has potential to re-ignite volatility.
Tight valuations and high uncertainty usually mean trouble, and we suspect 2025 will make no exception.
We enter the year with lowest net credit exposure since 2022, off a combination of low net exposure and reduced weight in higher beta segments, such as financials and emerging markets. Our duration is 2.3y. Our yield to call is 5.6%. Our current positioning means we are well placed if a risk correction in 1Q25 materializes and have space to add risk in our cash book in this instance.
More in detail:
The Fund blended YTC is 5.6%.
The Fund duration is now 2.3y, on the low side of our historical range.
We currently run ~14% cash allocation, the highest in the past three years. We hold 43% protection on tight global CDS indexes and single name CDS.
Net exposure in financials (incl. cash short and single name CDS) represents 27% 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 4% of the Fund.
*Note indices are used to illustrate the relevant asset class
Financial Credit Strategy
The year ended on a mixed tone with December being very much a tale of two halves split by the FOMC meeting in the middle of the month. Risk assets had been largely positive to stable going into the decision but the perceived more hawkish stance by members led to a bear steepening of the US rates curve. This triggered a knee-jerk reaction across assets and was more evident in the equity space as the dispersion in geographical performance was one of the widest in quite some time.
Whilst European indices held onto their c2% gains, with Italy once again outperforming +2.3% vs UK -1.3%, it was a different picture in the US: the broader S&P fell c2.5%, the defensive Nasdaq rose c0.5%, whilst the Russell sharply dropped c8.5%. Also, there was a sharp reversal across the Financials space with European entities adding c5%, taking YTD to c32%, whilst US peers gave up c7.5% in the month but still ended 2024 ahead with +c37%.
Across the credit space, AT1 spreads once again stood out across other parts of the financials’ capital stack, rallying a further c30bps in December and taking YTD gains to c175bps. The unrelenting hunt for yield in combination with ongoing fundamental amelioration should continue to provide a tailwind for the sector as the incremental pick-up over more traditional credit classes like corporate IG and HY remains attractive from a historic perspective.
European financials should remain in the M&A spotlight as the few ongoing transactions continue to see further progress going into the new year. Italy and UK financials remain the most active on the newsflow front though we could finally see some closure in both Spain and Germany in 2025. Faced with the prospect of lower European interest rates as the ECB attempts to arrest the economic slowdown, some banks’ management teams might be forced to embrace offers as the unfortunate combination of weakening interest income and higher running costs weigh on profits.
Primary activity in December was particularly subdued at just EUR5bn given issuers had been quite active coming into the end of the year. Compared with 2023, capital issuance last year was c50% higher whilst funding in the secured format contracted c40%. Considering that over the past 5 years, secured debt has accounted for roughly half of European financials primary, it will be interesting to see this year how issuers adapt to less attractive levels in this format.
Financial Equity Strategy
2024 was another strong year for the fund, with ~450 bps of alpha and very strong absolute returns as well. This represents the fourth year in a row of alpha generation of at least 400 bps, in what has been a volatile backdrop with sharply divergent market landscapes to navigate (post Covid recovery bounce in 2021, equity/bond market declines in 2022, bank failures and take-unders in 2023, and political volatility of 2024). Our aim as always remains to navigate whatever the market has to offer, with an intense focus on absolute return and maintaining flexibility in what is a highly mean-reverting and volatile sector. As we assess the always-evolving Financial sector landscape at the outset of another year, we continue to see highly compelling and asymmetric risk reward opportunities across European banks and US life insurance. Intriguingly, US banks are becoming increasingly attractive as well.
Briefly in terms of fund performance in 2024, it is notable that every subsector contributed positively, though banks generated the lion share (~2/3) of performance. Insurance was the other key positive contributor, at just under 20% of total performance. Geographically, Europe and the US were the largest drivers, consistent with our exposure throughout the year. By name, just three holdings cost the fund more than 15 bps in 2024, while 27 holdings contributed at least 50 bps of positive PNL. Top individual contributors were Barclays, Standard Chartered, Equitable, Unicredit, Santander, Direct Line, Beazley, and Carlyle – representing a diversified mix of our key bets across banks, insurance, and diversified financials.
Looking forward, the portfolio will look to position tactically towards European banks, at both an active and absolute level. We are highly constructive on the space as valuations remain very compelling and capital returns over the next 2-3 years will be enormous. As we have discussed extensively, even after an excellent few years for European bank stocks, they are only back to 2017 levels in absolute and valuations are stuck at prior trough levels (~6.5x forward earnings). We believe bank profitability in Europe will prove to be much more resilient than expected, which should ultimately drive a powerful re-rating in the sector. Just to go back to historical ~10x valuations would represent significant upside from current levels. Robust growth in dividends and tangible book value per share – both of which were largely absent in the past decade – should underpin continued strength in shares even in what will inevitably be a volatile macro and geopolitical backdrop in the next 12-24 months.
Another notable shift in portfolio positioning this past year is our increased exposure to Insurance, which was ~15% at the end of 2023 and now sits just above 25%. This is due primarily to our holdings across US life insurance, a space we are extremely bullish on given robust balance sheets, strong free cash flow yields, and business models that will benefit from higher rates and steeper yield curves. We have also stepped up exposure to non-life insurance in the UK as profitability has been significantly enhanced by harder markets of recent years, with capital return now likely to feature prominently. M&A is also likely to continue to feature in both subsectors in the next 12-18 months, for which we are well positioned.
Where we have been most tactical over the last couple of years has been US banks, as the space has been tremendously volatile in the backdrop of the Fed hiking cycle, bank failures, regulatory changes, and most recently election uncertainty. After a strong November which saw large and small US banks gain 13% and 15%, respectively in the wake of the US elections, a large portion of those gains reversed in December with many bank stocks now below their pre-election levels. As we wrote about in last month’s commentary, we utilized the strong initial rally to reduce our US bank exposure. But in recent weeks we have taken advantage of the dramatic weakness to rotate into names in which the outlook has become more favourable amidst the sell-off and resulting deratings. The materially steeper yield curve (the key spread between 3-month and 5-year rates steepened by over 100 basis points in 4Q24, turning positive for the first time since 2022) is supportive of the fixed asset-yield repricing dynamic which will serve as a powerful tailwind for bank net interest income growth over the medium-term. This is a sharp reversal of a major earnings headwind over the past 18-24 months. Additionally, the easing regulatory environment should lead to notably increased capital return compared to prior years. Indeed, in early January, the Fed’s Vice Chair for Supervision Michael Barr stepped down from his supervisory post; Barr was a key proponent of more stringent capital requirements. With his resignation – which was unexpected – the outlook for the Basel III Endgame proposal is likely even more favourable for the banks now, both in terms of substance and timing. Lastly, we have also invested in several banks undergoing accretive transactions such as acquisitions or securities restructurings. We certainly expect we will have more opportunities to deploy capital into similar situations, which tend to come at very attractive discounts for new investors.
Sustainable Equity Strategy
Market Commentary
December was a slightly negative month for global equities, with the performance primarily driven by the US stock market reaction to the Fed’s hawkish commentary. The Fed’s updated dot plot now signals fewer rate cuts in 2025, reflecting the continued strength of the U.S. economy.
US macroeconomic data remained robust, with Q3 GDP printing at 3.1% YoY and employment remaining strong. However, inflation was meaningfully above the 2% target level, with Core CPI coming in at 2.6% YoY in November. While the Fed reduced rates by 25 basis points in December, Chair Powell signaled fewer rate cuts in 2025, contributing to further U.S. dollar appreciation against the euro. Elsewhere, the ECB cut rates by 25bps in December and confirmed expectations for further rate cuts in 2025 as the economy stagnates. This comes despite a recent rebound in core inflation, with Core climbing to 2.7% YoY in December.
Portfolio performance
The Algebris Sustainable World Fund returned -6.5% in December, bringing YTD return to +7.5%. The return for the month has been driven by the strong performance of Core&Main (largest stand-alone waterworks/fire protection distributor in the U.S. with a network of ~350+ branches across 49 states), ASML (based in the Netherlands, it’s a global leader in developing, producing, and marketing semiconductor manufacturing equipment, specifically machines for the production of chips through lithography) and Siemens (German engineering and manufacturing company, which focuses on electrification, automation, and digitalization.).
In terms of portfolio activity, we rebalanced some positions in Europe, increasing EssilorLuxottica, ASML and Prysmian, while in US we increased Core&Main, following strong quarterly results.
Strategy
The performance has been driven by our top-down fundamental approach due to several factors. First, 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.
Note: Index is used to illustrate the relevant asset class
Global Credit Strategy
How we did in December: The fund returned between 1.03% and 0.62% across different share classes, while EUR HY (BAML HE00 Index) returned 0.6%, US HY (BAML H0A0 Index) -0.4% and EM sovereign credit (BAML EMGB Index) -1.7%. Performance in December, gross of fees in EUR, was: (i) Credit: 48bps, with 40bps from cash bonds and 8bps from CDS; (ii) Rates: 19bps; (iii) FX: 6bps, (iv) Equity: 46bps and (v) Other: 0bps.
What we are doing now: Global risk enters 2025 with tight valuations and long positioning across asset classes. Credit spreads are close to 2021 tights and cash levels are low despite sustained inflows. A pickup in rates volatility or an equity market correction may thus hurt credit, particularly given the negatively asymmetric starting point.
The risk-reward in US rates is more balanced than a month ago as the hawkish December FOMC removed the bulk of 2025 cuts from the curve. However, the US curve is still flat by historical standards and is gradually steepening out the five-year point. US policy noise around the new administration inauguration has potential to re-ignite volatility.
Tight valuations and high uncertainty usually mean trouble, and we suspect 2025 will make no exception.
We enter the year with lowest net credit exposure since 2022, off a combination of low net exposure and reduced weight in higher beta segments, such as financials and emerging markets. Our duration is 2.3y. Our yield to call is 5.6%. Our current positioning means we are well placed if a risk correction in 1Q25 materializes and have space to add risk in our cash book in this instance.
More in detail:
*Note indices are used to illustrate the relevant asset class
Financial Credit Strategy
The year ended on a mixed tone with December being very much a tale of two halves split by the FOMC meeting in the middle of the month. Risk assets had been largely positive to stable going into the decision but the perceived more hawkish stance by members led to a bear steepening of the US rates curve. This triggered a knee-jerk reaction across assets and was more evident in the equity space as the dispersion in geographical performance was one of the widest in quite some time.
Whilst European indices held onto their c2% gains, with Italy once again outperforming +2.3% vs UK -1.3%, it was a different picture in the US: the broader S&P fell c2.5%, the defensive Nasdaq rose c0.5%, whilst the Russell sharply dropped c8.5%. Also, there was a sharp reversal across the Financials space with European entities adding c5%, taking YTD to c32%, whilst US peers gave up c7.5% in the month but still ended 2024 ahead with +c37%.
Across the credit space, AT1 spreads once again stood out across other parts of the financials’ capital stack, rallying a further c30bps in December and taking YTD gains to c175bps. The unrelenting hunt for yield in combination with ongoing fundamental amelioration should continue to provide a tailwind for the sector as the incremental pick-up over more traditional credit classes like corporate IG and HY remains attractive from a historic perspective.
European financials should remain in the M&A spotlight as the few ongoing transactions continue to see further progress going into the new year. Italy and UK financials remain the most active on the newsflow front though we could finally see some closure in both Spain and Germany in 2025. Faced with the prospect of lower European interest rates as the ECB attempts to arrest the economic slowdown, some banks’ management teams might be forced to embrace offers as the unfortunate combination of weakening interest income and higher running costs weigh on profits.
Primary activity in December was particularly subdued at just EUR5bn given issuers had been quite active coming into the end of the year. Compared with 2023, capital issuance last year was c50% higher whilst funding in the secured format contracted c40%. Considering that over the past 5 years, secured debt has accounted for roughly half of European financials primary, it will be interesting to see this year how issuers adapt to less attractive levels in this format.
Financial Equity Strategy
2024 was another strong year for the fund, with ~450 bps of alpha and very strong absolute returns as well. This represents the fourth year in a row of alpha generation of at least 400 bps, in what has been a volatile backdrop with sharply divergent market landscapes to navigate (post Covid recovery bounce in 2021, equity/bond market declines in 2022, bank failures and take-unders in 2023, and political volatility of 2024). Our aim as always remains to navigate whatever the market has to offer, with an intense focus on absolute return and maintaining flexibility in what is a highly mean-reverting and volatile sector. As we assess the always-evolving Financial sector landscape at the outset of another year, we continue to see highly compelling and asymmetric risk reward opportunities across European banks and US life insurance. Intriguingly, US banks are becoming increasingly attractive as well.
Briefly in terms of fund performance in 2024, it is notable that every subsector contributed positively, though banks generated the lion share (~2/3) of performance. Insurance was the other key positive contributor, at just under 20% of total performance. Geographically, Europe and the US were the largest drivers, consistent with our exposure throughout the year. By name, just three holdings cost the fund more than 15 bps in 2024, while 27 holdings contributed at least 50 bps of positive PNL. Top individual contributors were Barclays, Standard Chartered, Equitable, Unicredit, Santander, Direct Line, Beazley, and Carlyle – representing a diversified mix of our key bets across banks, insurance, and diversified financials.
Looking forward, the portfolio will look to position tactically towards European banks, at both an active and absolute level. We are highly constructive on the space as valuations remain very compelling and capital returns over the next 2-3 years will be enormous. As we have discussed extensively, even after an excellent few years for European bank stocks, they are only back to 2017 levels in absolute and valuations are stuck at prior trough levels (~6.5x forward earnings). We believe bank profitability in Europe will prove to be much more resilient than expected, which should ultimately drive a powerful re-rating in the sector. Just to go back to historical ~10x valuations would represent significant upside from current levels. Robust growth in dividends and tangible book value per share – both of which were largely absent in the past decade – should underpin continued strength in shares even in what will inevitably be a volatile macro and geopolitical backdrop in the next 12-24 months.
Another notable shift in portfolio positioning this past year is our increased exposure to Insurance, which was ~15% at the end of 2023 and now sits just above 25%. This is due primarily to our holdings across US life insurance, a space we are extremely bullish on given robust balance sheets, strong free cash flow yields, and business models that will benefit from higher rates and steeper yield curves. We have also stepped up exposure to non-life insurance in the UK as profitability has been significantly enhanced by harder markets of recent years, with capital return now likely to feature prominently. M&A is also likely to continue to feature in both subsectors in the next 12-18 months, for which we are well positioned.
Where we have been most tactical over the last couple of years has been US banks, as the space has been tremendously volatile in the backdrop of the Fed hiking cycle, bank failures, regulatory changes, and most recently election uncertainty. After a strong November which saw large and small US banks gain 13% and 15%, respectively in the wake of the US elections, a large portion of those gains reversed in December with many bank stocks now below their pre-election levels. As we wrote about in last month’s commentary, we utilized the strong initial rally to reduce our US bank exposure. But in recent weeks we have taken advantage of the dramatic weakness to rotate into names in which the outlook has become more favourable amidst the sell-off and resulting deratings. The materially steeper yield curve (the key spread between 3-month and 5-year rates steepened by over 100 basis points in 4Q24, turning positive for the first time since 2022) is supportive of the fixed asset-yield repricing dynamic which will serve as a powerful tailwind for bank net interest income growth over the medium-term. This is a sharp reversal of a major earnings headwind over the past 18-24 months. Additionally, the easing regulatory environment should lead to notably increased capital return compared to prior years. Indeed, in early January, the Fed’s Vice Chair for Supervision Michael Barr stepped down from his supervisory post; Barr was a key proponent of more stringent capital requirements. With his resignation – which was unexpected – the outlook for the Basel III Endgame proposal is likely even more favourable for the banks now, both in terms of substance and timing. Lastly, we have also invested in several banks undergoing accretive transactions such as acquisitions or securities restructurings. We certainly expect we will have more opportunities to deploy capital into similar situations, which tend to come at very attractive discounts for new investors.
Sustainable Equity Strategy
Market Commentary
December was a slightly negative month for global equities, with the performance primarily driven by the US stock market reaction to the Fed’s hawkish commentary. The Fed’s updated dot plot now signals fewer rate cuts in 2025, reflecting the continued strength of the U.S. economy.
US macroeconomic data remained robust, with Q3 GDP printing at 3.1% YoY and employment remaining strong. However, inflation was meaningfully above the 2% target level, with Core CPI coming in at 2.6% YoY in November. While the Fed reduced rates by 25 basis points in December, Chair Powell signaled fewer rate cuts in 2025, contributing to further U.S. dollar appreciation against the euro. Elsewhere, the ECB cut rates by 25bps in December and confirmed expectations for further rate cuts in 2025 as the economy stagnates. This comes despite a recent rebound in core inflation, with Core climbing to 2.7% YoY in December.
Portfolio performance
The Algebris Sustainable World Fund returned -6.5% in December, bringing YTD return to +7.5%. The return for the month has been driven by the strong performance of Core&Main (largest stand-alone waterworks/fire protection distributor in the U.S. with a network of ~350+ branches across 49 states), ASML (based in the Netherlands, it’s a global leader in developing, producing, and marketing semiconductor manufacturing equipment, specifically machines for the production of chips through lithography) and Siemens (German engineering and manufacturing company, which focuses on electrification, automation, and digitalization.).
In terms of portfolio activity, we rebalanced some positions in Europe, increasing EssilorLuxottica, ASML and Prysmian, while in US we increased Core&Main, following strong quarterly results.
Strategy
The performance has been driven by our top-down fundamental approach due to several factors. First, 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.
Note: Index is used to illustrate the relevant asset class