The eyes focused on Greece in July, who cares about PSPP?


Fund Commentary
21 Aug 2015


In July, the markets were still very nervous due to the Greek crisis. Fears of Grexit and a Greek default led to many uncertainties and increased volatility. In addition, once Greece and its creditors found a solution to avoid the worst case scenario, Chinese equity markets started to decrease substantially. Immediately questions and doubts about the pace of the Chinese growth arose again.

In the US, economic statistics were dominated by the publication of the GDP figures for Q2 (annualised) at +2.3% and the final revision of the GDP figures for Q1 2015 at +0.6% against -0.2% (and -0.7%, first estimation). The non-farm payrolls number (+223k) was in line with expectations and the unemployment rate decreased from 5.5% to 5.3%. Inflation remained low, with a CPI (ex-food and energy) of +0.2%. The Federal Reserve (Fed) kept its monetary policy unchanged and the expectations of a first rate hike are expected in September by the most optimistic analysts, and in early 2016 for those who believe that the Fed should postpone the normalisation of its monetary policy, due to international issues. Ms Yellen said that the Fed is likely to raise its interest rate this year, but the timing of lift-off is less important than the subsequent pace of increases which would be gradual. She added that the Fed monetary policy will probably remain highly accommodative for quite some time. In Europe, the discussions between Mr Tsipras (Greek PM) and European governments (mostly Germany and France), the ECB and the European Commission relegated all the other topics, such as economic statistics, to the second level. In this nervous environment, one major event has almost passed without comment: on 2 July, the ECB extended its QE list to 13 new names called PSPP (Public Sector Purchasing Program). These names are corporate issuers, partially or totally State-owned, such as the Italian Enel for example. They belong essentially to three main sectors: transportation, utilities, oil and gas. The Investment Adviser believes that this is the first step to the publication of a larger buy-list including other Government-related issuers and if needed, a possible further step to high quality corporate issuers (AA-A rated).

Given this very uncertain backdrop, with a Grexit probability changing almost every day from very high to very low and vice versa, the German government yield curve experienced a bullish flattening this month: the 2y yield stayed at -0.23%, the 5y yield decreased from 0.08% to 0.05% and the 10y from 0.76% to 0.64% (-12 bps) with a high on 10 July  at 0.90%. On the credit side, corporate spreads behaved differently on both sides of the Atlantic: if the US corporate CDX index did not really move, from 70 to 71 bps, the European iTraxx Main tightened from 76 to 62 bps as a consequence of the decline of risk aversion, once the Greek worst case scenario has been avoided.

In July, the management style and the investment process remained unchanged, but the Fund Management Team improved the strategy of the Fund in order to be more efficient in terms of low volatility and low correlation between corporate spreads and the behaviour of stock markets. As the Strategic Euro Bond Fund is considered a natural hedge to investment in equities, the Investment Adviser paid more attention to the potential impact of a correction in equity markets on credit spreads held in the portfolio. In practice, it means that BBB spreads (high correlation with stocks) and Korean issuers (high correlation with China) should be decreased as they would suffer the most should any correction of equity markets materialise. At the same time, the publication of the PSPP list (please see above) has led to an evolution of the composition of the portfolio with less credit risk and more PSPP bonds or issuers that will potentially be included in a PSPP tobuy-list. In addition, buying PSPP names is the guarantee that these bonds will stay very liquid, the ECB being the buyer of last resort in an environment where corporate spread liquidity is becoming a worrying issue. This strategy has been implemented when the assets of the Fund climbed substantially, from 114 to 144 
million EUR. 

Consequently, the Investment Adviser sold or decreased the weight of the following bonds: Republic of Korea, Export-Import bank of Korea, Korea Gas (decreasing the weight of Korea from 9.7% to 3.3%), Adecco, Imerys and Wendel (all BBB rated).  The following PSPP bonds: Enel (Italy), OeBB infrastruktur (Austria), BNG (Netherlands) and ICO (Spain) were also  purchased, likewise issuers that have a high probability to be included in a probable PSPP 2 list: TenneT (Netherlands), Aéroports de Paris (France), Nederlandse Gasunie (Netherlands), EDF-RTE (France), BordGais-Ervia (Ireland), Deutsche Bahn (Germany) and Engie (EX-GDF-Suez, France). Finally, as a consequence of the amount of net subscriptions this month (+ 30 million EUR), the Investment Adviser also bought high-quality corporates such as Linde AG, BASF, SAP, Siemens, Anheuser-Busch and Telstra and also increased the weight of Telekom Austria (BBB rated but subsidiary of America Movil, A rated and the Austrian Government AA+ rated). At month end, the Fund held 62 issues and 61 issuers and the weight of PSPP bonds reached 6.1% while the weight of probable PSPP 2 issuers reached 16.6%.

The duration overlay policy has been active this month due to the Greek crisis. In this environment, the Investment Adviser increased the modified duration of the Fund from 2.1 to 2.7 once fears of Grexit and Greek default decreased substantially.

The Investment Adviser believes that the ECB will remain very accommodative and that Mr Draghi will continue his “whatever it takes” policy. The Central Bank is ready to intervene to prevent a major drawdown of the markets. The liquidity of the bond market is a major issue and the Investment Adviser will continue to be invested in liquid assets such as PSPP bonds. Depending on the development of the markets, the Investment Adviser may maintain the duration risk of the Fund between 2.2 and 2.7. Peripheral corporate spreads will not be considered as a buying opportunity even though the Investment Adviser chose to invest in Italian (1.1%), Spanish (1.8%) and Irish (1.2%) PSPPs. The average quality of the portfolio has been dramatically improved in July despite the small decrease of the S&P score of the Fund, from 82.5 to 77.2 points. This is due to the fact that the decrease of BBB corporates has been offset by the purchase of Peripheral PSPP bonds which are also rated BBB but offer much more quality and liquidity.

The fund management team 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 14/08/15.