Market backdrop
Credit markets ended the month in the green, with spreads on eurozone (EUR) investment grade (IG) corporates tightened by 8 bps to 129 bps. Markets have remained fairly complacent in the face of mixed macro data and hawkish narrative from central banks, focusing on disinflationary trends and a soft landing scenario. Following relatively sizeable supply in the first part of the month, supportive technicals (inflows into credit funds) have swiftly driven credit markets tighter. This is despite a sharp re-pricing of the European Central Bank (ECB) and the Federal Reserve (Fed) rate cuts in the very near term, with the market now pricing in a probability of a rate cut in March by the Fed of circa 35% compared to more than 80% at the beginning of the month. Rates have moved higher over the month, with Germany 10- year Bund Government Bond Yield up 13 bps (after initially increasing by more than 30 bps) and the curve steepened.
EUR IG corporate total returns were marginally positive in the month (+0.14%), driven by tightening spreads, which more than offset the impact of higher rates.
Performance
During the month, the fund’s NAV (Z class, EUR) was up 0.25%.
In January, financials outperformed non-financials (spreads on EUR IG financial corporate bonds tightened by -11 bps vs -6 bps tightened for spreads on non-financial corporate bonds), with insurance subordinated debt being particularly strong (-18 bps during the month).
Positioning
Issuance of green bonds from European financials was fairly muted in January, with only USD 3.5 billion printed over the month, mainly from peripheral issuers. This is sharp decline compared to USD 12.7 billion in January 2023 and USD 6 billion in January 2022. Nevertheless, we expect the supply of green bonds to remain strong over the year.
The fund’s positioning has not materially changed over the month, with part of the portfolio de-risked towards the end of 2023. Banks have started to report Q4 earnings at the end of January, which have remained solid. While the benefits from higher interest rates have largely materialised, the sector is now delivering strong returns (double-digit return on equity) that bode well for bondholders. Capital metrics remain at very strong levels, and asset quality trends show very limited signs of deterioration. As an example, Banco Santander reported a net profit of EUR 11.1 billion for the full year, up 18% year-over-year (YoY) (Q4 earnings up 28% YoY), a circa 15% return on tangible equity. Non-performing loans were roughly unchanged at 3.1%, and loan loss provisions only slightly higher at 1.1% in FY23. The banks’ Common Equity Tier 1 capital (CET1) capital ratio was flat at 12.3% during the quarter, as capital generation was offset by distributions and regulatory effects.
The fund has not been materially impacted by the financial conduct authority (FCA)’s motor finance probe in the UK, which could lead to relatively sizeable fines for several UK banks. The fund has limited exposure to UK banks (less than 10%) and no exposure to those most impacted. Moreover, UK banks have the ability to absorb fines through earnings, with no material impact for bondholders.
Finally, while there have been some concerns in certain parts of the banking sector regarding lending exposures to commercial real estate (CRE), this is limited to a small number of institutions with more concentrated business models. The majority of European banks have limited exposure to CRE (typically circa 5% of loans), where the quality of these exposures is strong (typically secured, with loan-to-value ratios of circa 50%) – not a source of concern. The fund has no exposure to monoline banks focused on commercial real estate.
