Market backdrop
Sentiment was stronger in October, as spreads on EUR investment grade (IG) corporates tightened by 12 basis points (bps) to 104 bps. Spreads were well supported over the month, on a combination of robust macro data from the US and EU, the European Central Bank (ECB) delivering a 25 bps rate cut as expected and very strong technicals. Inflows into credit remained very strong, while supply has been limited as a large number of issuers were in blackout ahead of Q3 earnings releases – albeit this picked up towards the end of the month. Despite inflation data in line with or slightly lower on both sides of the pond, strong macro data in the US combined with increased odds of Trump winning the presidential election led to a sharp move in rates. Tensions in the Middle East that led to volatility in oil prices also supported the rates move. Rates in the US surged in October, with the yield on the 10-year US Treasuries up 50 bps, while the 10-year German Bund yield moved up by nearly 30 bps. Markets are now pricing in approximately four rate cuts in the US by June 2025, compared to around 6.5 at the beginning of the month. The reaction to Fitch and Moody’s changing the French government’s ratings outlook to negative was muted, with spreads on French OATs (French Treasury) tightening during the month. EUR IG corporates’ total returns were negative for the month, with the Bloomberg Euro Aggregate Corporates Total Return Index down by 0.31%. This decline was due to higher rates, which were only partially offset by tighter spreads and carry.
Performance
The fund’s NAV (Institutional class, EUR) decreased by 0.37% during the month. In October, financials performed in line with nonfinancials, with spreads 12 bps tighter for both. Insurance Tier 2s outperformed, tightening by 17 bps over the month.
Top performers in October were mainly shorterdated bank senior bonds and Tier 2s, which were less impacted by the decline in rates. Bottom performers were primarily longer-dated bank senior bonds and insurance Tier 2s, which suffered from duration.
Positioning
Issuance of green bonds from the European financial sector was decent in October, totaling USD 4.3 billion, compared to an average of circa USD 2 billion in October over 2021-2023. This was mainly driven by Nordic and Dutch issuers. We participated in a new green EUR-denominated Tier 2 from Svenska Handelsbanken, one of the large Swedish banks, that came at 3.7% yield or 164 bps of spread to government bonds, with a maturity in 2036 (callable in 2031), rated A3/A-/A+ by Moody’s/S&P/ Fitch. The deal screens attractively compared to the average spread of 90 bps and yield of 3.1% on A-rated IG corporates. On the earnings side, European banks continued to deliver a very strong set of earnings, mostly exceeding analyst expectations, with a number of upgrades to full-year guidance. Overall, the sector continues to deliver robust earnings, characterised by high levels of capital, strong earnings and resilient asset quality, which is credit positive. For example, NatWest delivered an 18.3% return on tangible equity (RoTE) in Q3 2024, as profits were up 35% year-over-year (YoY) and well ahead of consensus, driven by strong revenue growth and costs that remained under control. Management raised its RoTE guidance to be greater than 15% in 2024 based on higher revenue guidance. Capital remained strong, with a Common Equity Tier 1 (CET1) ratio of 13.9% (+0.3% on the quarter), compared to the 10.5% minimum requirement, resulting in GBP 6 billion of excess capital. Nonperforming loans (NPLs) remained very low at 1.5% of loans.
Outlook
We remain positive going forward, with attractive spreads against a backdrop of very strong credit quality. We continue to see financials as the most attractive part of the market, supported by rock-solid fundamentals and earnings that have benefitted from the normalisation of interest rates. With a yield (to next call) of around 3.8% and an average spread (G-spread) of circa 133 bps on the fund (compared to 3.3% and 104 bps for the EUR IG corporate market), we see this as an opportunity to capture high income with further upside potential from tightening spreads. This is despite the high-quality bias of the fund, which has an average bond rating of BBB+ and an average issuer rating of A.
