In September, the European Central Bank (ECB) cut interest rates and announced additional measures including a purchase program of asset-backed securities (ABS) and a larger program of quantitative easing if needed.
The economic situation deteriorated further in Europe and the risk of deflation is a growing concern, which may force the ECB to dramatically increase the size of its balance sheet. In the US, economic conditions continue to send a mixed picture, where GDP grew by 4.6 in the second quarter, car sales recovered to their pre-crisis level and Federal Reserve’s “Beige Book” of economic conditions indicated that the economy was moving at a modest-to-moderate pace.
However, US unemployment figures disappointed and Mrs Yellen, (Chair of the Board of Governors at the Federal Reserve) started to prepare the markets for the possibility of a first Fed Funds rate hike sooner than expected.
During the month, the yield of 2-Yr German Bko and the 5-Yr Obl decreased by 5bps and 2bps, respectively, and the yield of 10-Yr Bund increased by 6bps. At the same time, the yield of Italian and Spanish 10-Yr Government bonds decreased by 10bps and 9bps, respectively. On the credit side, investment-grade corporate spreads increased slightly from new lows in both the US and Euro markets: the Markit North American Investment Grade CDX index increased from 57 to 64 bps and the European Markit iTraxx index edged higher from 60 to 63 bps.
The assets of the Fund increased further during the month from EUR 100.4 to 102.3 million. The Fund bought Wendel (French Industrial Holding Company recently upgraded from BB+ to BBB-) in the secondary market and the new Toyota and LVMH in the primary market. In addition, the position in Telekom Austria bought in August and the positions in Airbus and ASF were increased against the sale of Anheuser Busch-Inbev following uncertainties regarding its recent M&A activity. The position in Teva was sold and exposure to Edenred and Pemex, all BBB rated bonds, were reduced in order to finance the investment in Wendel. The exposure to Siemens and BASF also decreased against the purchases in the primary market. Finally, the Fund made an extension trade where BMW 2017 bond was sold and proceeds were reinvested in the BMW 2022 bond.
At the end of the month, the Fund held 48 issues but 46 issuers.
The duration overlay policy has been stable in September. Corporate bond trades increased the modified duration of the portfolio from 5.54 years to 5.72 years. The short Bund position was also increased from 210 to 220 contracts. Therefore the futures hedge position represented 46.3% of the modified duration of the Fund, which has been slightly increased during the month, from 2.92 to 3.08.
• Modified duration of the portfolio: 5.72
• Modified duration of the short Future position (10-Yr Bund only): -2.64
• Modified duration of the Fund: 3.08
Given the increasing risk of deflation and recession in Europe, we will maintain the modified duration close to 3 years which is near the maximum of the Fund’s investment strategy.
On the credit side, we will pursue our corporate bond picking process depending on both primary and secondary market valuation opportunities. Consequently, we remain confident that positive returns will be achievable thanks to the carry of corporates, their spread tightening potential, the credit selection and a very active duration and yield curve management.
Commentary provided by Banque Eric Sturdza in their capacity as Investment Adviser to the Fund as of 09 October 2014.