Mr ‘Whatever it Takes’ has ‘No limit’


Fund Commentary
18 Feb 2016


In January, all eyes were focused on every bad news item that could deteriorate the political and economic climate in 2016: fears of hard landing in China (and renminbi devaluation), negative rates in Japan, oil prices and commodity prices in general, Emerging markets, the (too hawkish) Fed but also Brexit, Spain (with no Government), migrants in Europe, turmoil in Brazil, Donald Trump, Italian banks… #

In this context, macro-economic data seemed peripheral to investors. In Europe, German growth reached its largest annual gain in four years and Spanish unemployment its lowest level in five years but France did not improve and European inflation is still worrying. In the US, the picture remained unclear with good news (the 5% unemployment rate, consumer confidence at 98.1) offset by poor industrial production (-0.4%), durable goods orders (-5.1%) and a weaker than expected Q4 2015 GDP (+0.7% QoQ annualized). Inflation data was mixed with headline CPI reaching 0.7% and core CPI 2.1% (headline PPI at -1%, core at 0.3%) and average hourly earnings reaching +2.5% YoY in December which is notable as wage growth is key to reach the Fed’s inflation target. The BoJ took the market by surprise, adopting a negative interest rate policy, but other Central banks did not change their key rates and policies in January however due to the mood of financial markets and very poor inflation (or possible deflation) pressures in Europe, Mr Draghi said that the ECB program will be reviewed in March with “no limits” on how far they can go. In addition, reducing interest rates further is still possible, according to the December minutes.

In this context, the German yield curve experienced a bullish flattening, the 2y yield decreasing from -0.34% to -0.49% (-15 bps), the 5y yield from -0.04% to -0.31% (-27 bps) and the 10y Bund yield from 0.63% to 0.32% (-31 bps). On the credit side, the US corporate CDX index kept widening from 88 to 102 bps due to continuing signs of recession in some sectors of the US industry and the European iTraxx Main widened from 77 to 92 bps, led by spread widening in the banking sector. Both investment grade credit markets also suffered from a “flight to quality”, investors favouring government bonds (Bunds and US Treasuries) despite their lower yields.

In January, continuing the strategy that has been followed since June, the Investment Adviser continued to favour high quality and liquidity. He focused his attention on decreasing the weight of bonds maturing in 2021, reducing Pepsico, Essilor, Toyota, Syngenta and Rolls Royce. He sold Klépierre 2016, and reduced KFW and Enel to decrease their weight below 5%. Finally, as the Fund bought the new Sagess 2023, LVMH and Sagess 2022 were sold.

The Modified Duration of the Fund stayed above 2 and the duration overlay policy has been maintained with a short position of 250 Bobls and 70 Bunds vs 50 last month (in order to hedge the duration of the new Sagess 2023). In terms of portfolio diversification, the Fund held 48 issues from 43 different issuers.

The Investment Adviser believes that the ECB will stay ultra-accommodative and that Mr Draghi will announce an increase of the ECB’s QE in March. The economic conditions are not particularly improving in the Eurozone with low growth and, more importantly (as it is the unique mandate of the ECB) zero inflation. Regarding the Fed’s policy, the behaviour of the FOMC in 2016 is unclear: inflation is low, international issues are growing (Emerging markets, China in particular) and the Fed is expecting four rate hikes (25bp/Quarter) while markets are not pricing in any hikes (the 2y Treasury note yield reached 0.77% which is too low compared to the Fed dot-plots).

The Portfolio Manager is still extremely cautious on corporate spreads and on liquidity of the credit market. He will continue to focus his investments on PSPP and very high quality corporates.
High beta names will be avoided except very short maturities with a “buy and hold until maturity” strategy. The modified duration of the Fund may be maintained around 2.2-2.4. The Investment
Adviser will pursue this strategy during the following weeks and still believes that positive returns will be achievable as a result of the carry of PSPP bonds and high-quality corporates, their spread tightening potential, credit selection and active management of duration and yield curve.

The views and statements contained herein are those of Sturdza Private Banking Group in their capacity as Investment Adviser to the Fund as of 15/02/16.