Monthly comment
September was once again a month where we saw significant volatility on interest rates, as the higher for longer theme remains very much present. Inflation has been easing, but it remains too high for central banks and macroeconomic data remains resilient. Higher oil prices also contributed to higher interest rates. Spreads on our securities widened slightly during the month.
Valuations and Fundamentals
As stated above, spreads widened slightly in September. Spreads within Additional Tier 1 (AT1) markets are at extremely wide levels relative to other parts of the credit market. This is especially the case versus high yield (HY). Spreads on AT1s are close to 200 basis points (bps) wider than HY. That is despite the fact that most of the issuers we own are investment grade companies and going into a recession these credits should be significantly more resilient as demonstrated in the past. Financials are also benefitting strongly from the higher interest rate environment. Moreover, spreads of subordinated debt of financials remain at very wide levels historically and we believe this creates significant opportunities. As such, despite the current macroeconomic uncertainties, valuations are attractive and have significant room to tighten ie, for the prices of our securities to go up.
Subordinated Debt
The new issue market for AT1s continued reopening and we saw very strong demand for new issues in the last few months. BBVA issued USD 1 billion in September. This was following BNP, Erste Bank, KBC and Intesa in August. We did not participate in all of these new issues, as some of them actually highlighted the extraordinary value on the secondary markets. For instance, in the case of BBVA and Erste Bank, we did not participate in the new issues, as some of their existing bonds were at significantly cheaper levels. This is in part due to the fact that extension (or non-call) risk remains largely overstated; the AT1 market is still pricing more than 65% of the AT1s as if they will not be called, despite the fact that less than 10% of AT1s have historically not been called. Within other parts of the subordinated debt market, such as Restricted Tier 1s (RT1s), corporate hybrids and callable Tier 2s, we also see this extension risk as being largely overstated. During risk-off environments such as in 2022 and currently, callable perpetual bonds tend to reprice to maturity, creating a double-negative effect on prices. However, the reverse is true when markets are stronger, and as such we expect to see further strong recovery. As markets continue normalising, we should continue seeing more recovery while still capturing high income.
