Macro Backdrop
April was a very volatile month following President Trump’s ‘Liberation Day’ tariff announcements. Global equity markets, government bonds and foreign exchange were significantly affected by these announcements. Equity markets initially reacted very negatively and, excluding Covid-affected periods, we saw the VIX ‘fear index’ go to the highest levels in 10 years. However, this all began reversing following the subsequent 90-day pause announcement. One area which remained relatively immune to all this volatility was the corporate bond market. We did see spreads widen during the beginning of the month, but on a relative basis this was significantly less than other asset classes. For instance, credit spreads on Additional Tier 1 (AT1) Contingent Convertible bonds (CoCos) widened from 313 basis points (bps) to 420 bps on 9 April and then finished the month at 360 bps, which remains close to historical tights.
Valuations and Fundamentals
As stated above, spreads within credit market have widened, but the selloff was orderly and short-lived, as the Trump Administration announced a 90-day pause on the introduction of most new tariffs. This small selloff gave us an opportunity to add small amounts of AT1 CoCos at very attractive yields going from 8-9% to higher. We believe that, despite the pause and recovery, volatility is likely to remain elevated, especially as there is a possibility that we start seeing hard macroeconomic data deteriorate. As such, we believe some caution remains warranted. Extension risk, which looks at the percentage of AT1 CoCos priced to perpetuity or call, did go up during the month and is currently around 35-40%. This also justified our small increased exposure to AT1 CoCos. When market conditions are poor it tends to peak at 100% and when market conditions are very strong, this percentage tends to approach 0%, indicating that valuations are at their tightest. As such, from a risk-return perspective, we believe that there has been a small incentive to add to AT1 CoCos, but there remains more value in Tier 2 and senior bonds from financials, albeit less compared to a month ago.
Q1 earnings have begun to be released and results have remained extremely solid, coming above consensus expectations on average – while credit metrics remain robust. As an example, Barclays delivered very strong results with a Return on Tangible Equity (ROTE) of 14% versus guidance of 11% and their Common Equity Tier 1 (CET1) ratio was up by 30 bps.
Subordinated debt
The AT1 CoCo market did experience some volatility during April, although significantly less than other markets. This created some interesting buying opportunities. New 2025 AT1 issues were, as expected, more volatile as we saw the market having a small selloff. As an example, we bought some Deutsche Bank AT1 CoCos at 91.5% or a yield to call of more than 9% in Euros. Those were issued end of March at 100% and they are currently trading close to 97%. Our cautious positioning enabled us to take advantage of the selloff and add small amounts of AT1 CoCos at attractive levels. The AT1 CoCo market has significantly recovered since then. Moreover, we currently have a similar year-to-date performance versus the AT1 CoCo market, but have experienced significantly less volatility. As the macroeconomic backdrop remains highly uncertain, we believe that we might have other bouts of volatility which could create good opportunities for the fund, while our positioning should minimise any potential drawdown.
