Quality Emerging bonds still offer the best risk-reward profile


Fund Commentary
18 May 2017


In April, US economic data was disappointing with the notable exception of housing and unemployment figures. The Fed still expects two more rate hikes this year but, more importantly, has begun discussions regarding how to reduce the size of its huge balance sheet. Its securities portfolio could shrink in early 2018.

In Europe, another strong set of data showed evidence of accelerating growth. Consumption figures were strong and unemployment fell to 9.5%, the lowest level since May 2009. However, inflation remained too weak and the ECB confirmed that the current policy would not be modified in the short term. The main driver of the European bond market this month was the outcome of the first round of the Presidential election in France. Emmanuel Macron (24%) and Marine Le Pen (21.5%) have qualified for the second round, leading to a rally of the 10y OAT (-9bps) and a correction of the Bund (+8bps) on the Monday morning following the election.

In this context, the 2y US Treasury yield barely moved from 1.25% to 1.26% (+1bp), the 5y decreased from 1.92% to 1.81% (-11bps), the 10y from 2.39% to 2.28% (-11bps) and the 30y from 3.01% to 2.95% (-6bps). At the same time, the 30y inflation-linked Treasury yield hardly moved from 0.92% to 0.90%, leading to a slight decrease of the inflation breakeven from 2.09% to 2.05%. In addition, the 3 Month USD LIBOR increased from 1.15% to 1.17%. In Europe, the 2y German yield barely moved from -0.74% to -0.73% (+1bp) but increased substantially from -0.86% on April 18th to -0.67% on April 25th (+19bps) around the first round of the Presidential election in France. The 5y Bobl yield behaved in a similar way, from -0.38% to -0.39% (-1bp) but from -0.53% to -0.32% between the 18th and 25th. The 10y Bund stayed at 0.32% but reached 0.16% on April 18th and 0.38% on April 25th. At the same time, the French 10y OAT yield rallied from 0.97% to 0.83% (-14bps). The Italian BTP 10y and the Spanish 10y bond yields hardly decreased from respectively 2.31% to 2.28% (-3bps) and from 1.67% to 1.65% (-2bps). On the credit side, the European iTraxx Main rallied from 74 to 67bps, driven by the tightening of French corporate spreads, while the US corporate CDX index slightly decreased from 66 to 64bps. In Emerging Markets, the CDX 10y EM index rallied significantly from 271 to 249bps (-22bps).


During the month, the Investment Adviser slightly decreased the position in issuers whose weighting was close to 5% of NAV: Shell 2018, Würth 2018, Siemens 2018, BNG 2019, Nederlandse WaterschapsBank 2019, BMW 2020, TenneT 2020 and Enexis 2020. The Modified Duration stayed in the region of 1.3-1.4. In terms of portfolio diversification, the Fund held 36 issues from 35 different issuers.


During the month, the Investment Adviser took the decision to switch the remaining position in 30y TIPS (inflation-linked Treasuries) into nominal US Treasuries maturing in 2046. He also sold the remaining position in Ford 2018, EDF 2019 and Pepsico 2019 and decreased the weight of Microsoft 2018, EDC 2018, Linde 2018, Toronto Dominion 2018 and Oracle 2019. He built a position in US treasuries maturing in 2027 and bought four “high beta” issues in order to increase the average yield of the portfolio: Arcelor Mittal 2025 (4.32%, Treasuries + 211bps), Schaeffler Finance 2023- call 2018 (3.24%, Treasuries + 219bps), Viacom 2057-call 2022 (5.03%, Treasuries + 315bps) and EDF perpetual-call 2024 (5.71%, Treasuries + 363bps). As a result, the average yield to maturity increased from 1.8% to 2.2% and the modified duration climbed from 3.7 to 4.6 at Month end. In terms of portfolio diversification, the Fund held 40 issues from 37 different issuers.


On April 28th, the Fund celebrated its first anniversary, delivering a sound performance of +4.09% since inception.

During the month, the Investment Adviser lowered the weight of low beta countries and issuers such as Mol 2019, Lithuania 2020, Cnooc 2021, Pertamina 2022 and Bharti Airtel 2024. He also sold the remaining stake in Slovakia 2022. He increased the weight of Arcelor Mittal 2025 and bought the new issue Phosagro 2021 at 3.95% (Treasuries + 217bps). In terms of geographical breakdown, the top 3 countries were Russia (16.8%), India (11.4%) and China (10.8%). The rating allocation was 61.0% Investment Grade and 37.5% BB+ and BB. The breakdown of the portfolio in terms of market allocation was 95.8% Emerging Markets, 2.7% Developed Markets (i.e. Luxembourg/ArcelorMittal) and 1.5% cash. In terms of sector allocation, the Investment Advisor favoured Governments (39.0%) followed by Materials (23.0%) and Energy (13.2%). The modified duration stayed around 5.3-5.4 during the month. In terms of portfolio diversification, the Fund held 32 issues from 32 different issuers.


The Investment Adviser’s medium-to-long term global outlook is still very cautious but in the short term, he believes that a decrease of US Treasury yields is likely in May-June. At the same time, in Europe, Bund yields could increase due to less political uncertainties and increased pressure on the ECB to start normalizing its monetary policy. The Investment Adviser will continue to monitor closely the evolution of high beta Emerging Markets in order to seize any opportunity to reinvest in these regions which, probably, offer the best risk-reward profile in the bond market today (e.g. the Strategic Quality Emerging Bond Fund: +4.09% since inception, +3.35% Year-to-Date).


The views and statements contained herein are those of the Eric Sturdza Banking Group in their capacity as Investment Advisers to the Fund as of 15/05/17 and are based on internal research and modeling.