Monthly Commentary – November 2022 Climate Bond

Monthly review and performance 

Market sentiment was particularly strong in November, with EUR investment grade (IG) spreads 40 bps tighter on the month. Expectations of a ‘pivot’ in central banks’ monetary policy and better-than-expected inflation prints both in the US and Europe led to a strong rally in markets globally. Lower rates (10-year Bunds down roughly 20 bps on the month) have also supported total returns. Flows have also been supportive, as EUR IG funds have seen inflows overall over the past month driven by lower rates and tighter spreads. Subordinated debt outperformed senior debt in the rally, as IG-rated Tier 2s from banks and insurers tightened by circa 50 bps on the month, and EUR Additional Tier 1 contingent convertible bonds (AT1 CoCos) tightened by more than 80 bps. Total returns were strong in November – ranging from +2.8% on EUR IG to +6% on EUR CoCos.

Supply of green and sustainability bonds from European financials was fairly high during the month at EUR 10 billion, compared to EUR 6.6 billion in November 2021 and EUR 1.8 billion last month. Supply came only in senior format and EUR only, but from a wide range of issuers – around half from peripheral banks, reflecting the improved market conditions. Issuers have been active in front-loading supply given macro uncertainty. We believe fundamentals remain strong, as Q3 results have continued to reflect the strong tailwinds from higher rates. As an example, despite elevated catastrophe losses in 2022, Munich Re delivered a 8.5% return on equity in Q3 and its solvency ratio continued to rise to 254%, +27 percentage points (pts) compared to the end of 2021. In the banking sector, we continue to see higher rates boosting the sector’s profitability. The magnitude of the tailwind is material – for example consensus estimates for NatWest’s return on equity in 2023 have gone from 7.7% in the beginning of 2022 to 11.4% currently, or roughly an extra GBP 1 billion of net income. This continues to reinforce our conviction that the financial sector is now defensive (from a credit perspective) as the potential impact from a recession (rise in non-performing loans, etc.) can be managed through earnings only – leaving excess capital unscathed at rock solid levels.

In our view, valuations remain attractive, fully disconnected from fundamentals of financials that would remain strong even in a weak macro scenario – as demonstrated by third quarter results. The disconnect is even more shocking as bank equities are close to flat on a total return basis year-to-date, while EUR AT1 CoCos are down close to -13% for example, and bank credit has underperformed non-financials. We have added to several attractive areas during the month, for example ANZ’s EUR 0.669% Tier 2s maturing in 2031 with a call date in 2026 that was offering a yield to call of 6.3% in early November (spread of more than 400 bps) for a BBB+ bond of a A+ issuer. The bonds had widened aggressively in early November as the Australian regulator emphasised the need for banks to make calls on subordinated debt only based on economics (ie if cheaper to refinance). After engaging with the large Australian banks, this was clearly misinterpreted as this was only a speech reiterating existing regulation, and according to our understanding this does not imply any change to Australian banks strong track record of calling at the first call date. We have also been tactically reducing our exposure to Generali, as bonds have strongly outperformed the rest of the market, switching into other core insurers such as Macifs that offer more than 100 bps of spread/yield pick-up and rated a notch higher. 

With a yield (to next call) of around 5.2% and an average spread (G-spread) of circa 300 bps on the fund (compared to 3.9% / circa 180 bps for the EUR IG corporate market), we see this as an opportunity to capture high income with upside potential from tightening spreads. This is despite the high quality bias of the fund (average bond rating of BBB+ / average issuer rating of A) and lower duration compared to EUR IG corporates (4.2y vs. 4.7y). 

Project corner : BVBA