June was a very weak month for risk assets, concluding a weak first half of the year. To put this into context, from a total return perspective, subordinated debt had one of its worst months in the last decade. High CPI numbers and hawkish statements from central banks have contributed to the weak market sentiment in general. It seems that investors are having a tough time assessing what the neutral rate should be and this has weakened asset prices. However, within the subordinated debt of financials, valuations are extremely attractive in our view. On top of that, the income part of our securities has become very significant. As an example, the yield to worst (YTW) on the fund is around 6%, with a number of securities which have yields well above that. Moreover, most subordinated debt is pricing extension risk. As an example, Additional Tier 1 (AT1) securities are perpetual bonds which have call dates. During positive market periods, most of the AT1 securities are priced to the next call date. However, during risk-off environments such as this year, a large number of those securities reprice to perpetuity. This creates a double negative effect on prices. As the large majority of our bonds are pricing the extension risk, we expect to benefit going forward as valuations tighten. Moreover, Credit Suisse called an AT1 bond at par, which was trading at 96% and replaced it with another USD AT1 which has a 9.75% coupon. Barclays also issued a GBP AT1 contingent convertible with a coupon of 8.875%. The Credit Suisse example shows us that investors are currently pricing too much extension risk.

Regarding rising interest rates, it is very important to note that financials benefit from that as the profitability increases. Therefore, despite the negative first half of the year and current weak sentiment, we believe our fund is well positioned to perform strongly during the second half of the year. We are currently capturing high income and believe that valuations are at attractive levels, especially as credit fundamentals remain very strong in our view.

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