- Date:
Marketing Communication
Executive Summary
Key events in market
The Short Term US Credit bond market delivered a negative performance in October with longest maturities the worst performer. US Treasury yields rose across all the curve in October. The 5y yield increased by 60bps while the longest part (10y)was up by 50bps.
Key performance & positioning updates
At the end of October, the Fund delivered a negative absolute return of -0.58%, slightly below the reference index which recorded -0.44%. The Fund ends the month with an A rating, 4.99% in terms of yield, and modified duration at 1.92 years (vs 1.84 years of the reference index).
Market Update
The MSCI World All Countries index corrected in October, registering a total return of -2.2% in the month. However, the performance since the beginning of the year remains a solid 16.4%. The performance of the MSCI ACWI was burdened by the correction in China and Asian markets as the surge seen in September was not supported by credible announcements of fiscal expansion. The month saw also increased volatility: the Vix index of implied volatility in SP500 options rose to above 22 from about 16 at the beginning of the month, levels that unsurprisingly represented a headwind to global equities.
The weakness of stock prices mirrored a sell off in fixed income markets, with the US Treasury 10-year yield adding almost 0.50% to rise to the highest since early July. Notably, the yield increase reflected a higher risk premium on top of upwardly revised expectations about future monetary policy. Furthermore, inflation expectations increased in the period, although the price of commodities, including oil, industrial metals and agricultural goods, fell. Finally, the US dollar index appreciated by more than 3%, this happened despite the price of gold of surging more than 4% for the month.
As much as these developments seem contradictory, they closely align with the increased belief amongst investors that the Republican party candidate Donald Trump has a better chance of winning the US Presidential elections than vice President Kamala Harris, the Democratic party candidate. Increased investors’ focus on the US elections overshadowed the European Central Bank decision to cut rates again in October and the UK budget by the new Labour government under Keir Starmer.
Fund Performance & Positioning
In October the Fund delivered a return of -0.58%, slightly below the reference index. Positive relative performance can be attributed to the overweight in the very short part of the curve, that contributed around 18bps to the performance. However, the overweight in the longest maturity bonds cost the Fund around 28bps.
On duration, the Fund maintained a neutral stance (1.92 years vs 1.84 years of the reference market): we still hold almost a 1 year underweight in the bucket 1-3y which is compensated by overweight in the 0-1y (+0.07y) and 3-5y (+0.90y). Looking at factor contribution we have 41% given by 3 years exposure, 23% from 5 years, 18% from 2 years and 11% from 1 year. 7% comes from credit spread.
From a sector point of view, the Fund maintained a similar exposure as the reference market in the financial sector (55% vs 47%). What still differentiates us is the broader diversification in terms of countries and issuers given that we’re underweight 19% on US names. We don’t hold any subordinated debt or US regional banks, and we maintain 5% in very short dated USTs. They’ve been used for their high liquidity in case of new issues and repositioning, and also attractive yields provided. Looking ahead, market opportunity will determine our holding of USTs.
In terms of countries, we are well diversified outside of the US. We are exposed to 12 countries belonging to the benchmark (out of a possible 20), and five more which are outside the reference index and supranational (9%). Our major exposure outside the US (41.7%) is in Canada (10%) and France (9.5%). Our major underweight is in the US (-38%), mainly due to underweighting financials (-19%) and Industrials (-5%).
Looking at ratings, we continue to keep an overweight on the higher rating buckets AAA/AA (+16.4% vs benchmark), slightly overweight on the A bucket (+0.8% which represents 44% of the portfolio) while always underweight on BBB bucket (at 19%, which is -17% vs the benchmark). We are invested in 89 positions (vs 1,544 of the reference index).
In terms of trading activities, we joined the primary market with JPM ’28 and HYNMTR ’27. Following some maturities, we also increased some existing positions (SOCGEN ’27, LLOYDS ’28, BMO ’27 ) to increase the bucket 1-3y. It’s worth noting that such a decision was taken in accordance with our investment process which includes an analysis using our risk framework.
The Fund starts the new month with an A average rating (vs A- of the reference index), with a 4.99% in terms of yield and 1.92 years in terms of duration.
With the normalization of the yield curve in place, and given the multiplicative effect of the duration, our investable universe should be positively impacted by the slightly longer maturities. Therefore, we have been repositioning the portfolio to some longer duration. This has temporarily increased the absolute risk however, this is still below the benchmark (1.60% vs 1.84%). We believe the opportunity is worth the slightly higher risk.
Given the fact we are still finding enough opportunities in the investment grade market, we do not see the need to consider high yield issuers. Our defensive positioning allows us to avoid taking aggressive and volatile positioning (high yields and/or subordinated bonds). As a reference we have never been invested in Credit Suisse, China, Russia or real estate linked issuers.
The Fund has all USD denominated issuers, so no Forex exposure. In addition, we remind readers the Fund is an Article 8+ with 54% ESG score vs 52.5% of the reference index.
Outlook
The elephant in the room for November is the US elections and the volatility linked to this. Trump’s agenda of tariffs, tax cuts and immigration curbs would prove inflationary in the US, initially sending US yields higher. A Harris victory would see US yields and USD paring part of recent gains.
Fixed income markets have been sensitive to each point data that signaled the likelihood of a soft landing rather than hard landing scenario. The consensus has clearly shifted towards the first camp in terms of economic growth. In fact, solid US data have also boosted yields and curbed rate cut expectations.
In the last month the fed fund futures started to price a less aggressive monetary policy path for the coming months. In fact, markets expect a 25bps interest rate cut for the meeting of November and an additional 80% probability of a further rate cut by year end. Markets have repriced up the path for key rates, after the solid activity data and anticipating the inflationary effect of a Trump victory. The tone of the communication by Federal Open Market Committee members has not changed during the last weeks and still sticks to a positive assessment of inflation and a data driven approach. Therefore, it is likely that Chair Powell will stay data dependent over the coming weeks, focusing more on labor market data, as these will probably shape the pace of future cuts.
As a final consideration, investment grade spreads are expected to hover around current levels in the coming months, keeping carry attractive vs sovereigns. Rating agencies have begun to adopt a cautious stance on the most cyclical European companies, either by downgrading ratings or revising outlooks downward. For this reason, selection is and will remain very important. We carefully watch ongoing automobile sector risk, where the transition to electric vehicles, intense competition from Chinese manufacturers, and sluggish demand from China are creating significant challenges. We also continue combining high quality floating rate and fixed rate securities to hedge against changes in central bank perceptions due to growth outlooks as well.
We continue to follow our approach which aims to maximize diversification through a strong and repeatable investment process, focused on risk. Our proprietary risk tool is picking up a series of small idiosyncratic risks in the investment universe that we wish to avoid, while we make sure we are better diversified on the primary risk factors. In fact, we continue to avoid subordinated bonds, regional banks, low liquidity issuers/bonds and countries such as China. Those elements seem to be (looking at the risk metrics) an important missing factor in our diversification but prefer not to be exposed to those factors. Being totally committed to delivering a cautious approach, we are fully aware we could miss some further tightening of spreads on riskier assets. We continuously screen our universe for the positions with the highest diversification potential in order to find new opportunities (including new issues on the market). Quantitative and qualitative expertise always challenge each other, in striving to deliver the best risk adjusted return for our clients.
We believe the portfolio is well positioned to capture the upside from stabilization in either a global negative or positive scenario by having a well-balanced exposure to credit, while being on a high potential position on the yield curve.
