Fraser Lundie Portfolio Manager
Market and Performance review
The Macroeconomic backdrop remains subdued, with a myriad of Brexit - related uncertainty and global trade tensions remaining unresolved. Global growth momentum continues to slowdown offset by supportive monetary policy. Data continues to disappoint versus expectations. Inflation expectations remain anchored, particularly in Europe.
With lacklustre global growth and increased policy uncertainty, the continued drop in government bond yields during Q3 encouraged gains across less risky bonds. Yields on 10-year Treasuries remained below those of 3-month Bills, keeping the yield curve inverted, signalling even weaker expectations relative to current conditions.
With, uninspiring earnings growth, credit metrics are slowly deteriorating in the corporate universe. Profitability in the banking sector is under pressure in this low interest rate environment while capital buffers built since the crisis are strong. The technical picture remains strong across credit markets. Large amounts of negative yielding assets are encouraging asset locators to look at spread products and we can see this in strong inflows across US, European, Emerging Market, High Yield and Investment Grade markets for the year-todate. Only two markets are lagging, these are Emerging Market Local and US Leveraged Loans.
Sentiment has improved, post European Central Bank announcement of additional monetary stimulus, with Equity & Credit volatility near two-year lows.
The Fund’s holdings in the Basic Industry, Energy and Banking sectors boosted its return the most. Index trades detracted the most. The individual holdings that contributed most were Enbridge, Enterprise Products (both Energy) and Allergan (Healthcare). Range Resources, Antero Resources and EnLink Midstream (all Energy) detracted. From a ratings perspective, BB and BBB issues boosted the Fund’s return the most. At the regional level, North America, Western Europe and Latin America drove performance.
Cash bonds continued to lag single-name CDS over the quarter, encouraging us to switch from CDS into bonds as this relationship reached highs in some capital structures.
Uncertainty surrounding Brexit enabled us to switch into Sterling-denominated bonds at an attractive pick-up compared with Euro-denominated securities from the same issuers.
Large amounts of negative-yielding debt around the world are driving demand for issues at the front end of curves, keeping curves steep and increasing the importance of extending the duration to optimise the Fund’s roll-down return. Furthermore, the longer end of high yield (15+ years) is looking particularly attractive from a historical perspective.
The Energy sector is trading two standard deviations cheaper than the high yield index over the past ten years, creating good opportunities for single-name selection within the sector. We added to mid-quality Energy issuers that are well positioned to withstand macroeconomic volatility.
Negative convexity remains an issue in the global high yield universe. Positioning in sectors that have better convexity, such as Energy, Basic Industry and Banking, is key to performance and as a result we reduced exposure to sectors with the worst convexity, such as Media.
There are opportunities in high-quality loans, including the new IQVIA Euro loan, which we added to our Loans pocket.
Within Emerging Markets we added to the Sovereign pocket as corporates outperformed sovereigns. We reduced exposure to high yield due to worsening convexity.
Ahead of the expected rebound in primary markets in Q4 we reduced our exposure to ABS, particularly in the UK. We increased the size of our options overlay and rolled the options’ maturity from September to November and
A dovish tone from central banks across the globe and progress in trade wars and Brexit have led to improved investor confidence. Accommodative monetary policy is back on the major central banks’ agendas: this will increase the proportion of negative-yielding assets but will act as a tailwind for spread products.
We see better risk-adjusted return potential in investment grade and the higher-rated segments of high-yield credit given the slowdown in the global economy. Overall, we favour bonds that are positioned to cope with macroeconomic weakness and have levers such as dividend cuts available to them. With credit curves currently steep, we favour lending for longer to stronger issuers, both in high yield and investment grade. CDS spreads are significantly lower than cash bond spreads at present, making cash bonds look more attractive than CDS in certain capital structures. Within Emerging Markets we added to the Sovereign pocket as corporates outperformed sovereigns. We reduced exposure to high yield due to worsening convexity. Ahead of the expected rebound in primary markets in Q4 we reduced our exposure to ABS, particularly in the UK. We increased the size of our options overlay and rolled the options’ maturity from September to November and December.