Monthly Commentary Novembre

USD

The month of November was marked by strong ‘risk-off’ behaviour as there have been more headlines related to Brexit, the Italian budget and trade wars.

The fund was not immune to these movements and, despite ongoing income gains of 0.5% and the 10-year US Treasury bond yield declining from 3.14% to 3.06%, the prices of securities held in the portfolio declined by approximately 2.7%. We wrote in October that this type of movement was extreme and does not reflect the strong quality of issuers held in the portfolio.

It is important to keep in mind that what drives the performance of the fund over time is the credit quality of the issuers we hold, combined with the steady and predictable income that we capture from their bonds. Prices can drop because of generalised negative sentiment but as the underlying credit quality has either not changed or has improved, they should recover once the dust settles. However, 6.375% HSBC Holdings, with a call option and reset in March 2025 at 4.368% over five-year swap rates, now trades at a mere 94.4%, off 2.7% over the month.

As at the beginning of December, there potentially seems to be more constructive news regarding both Italy and trade wars.

The stress tests conducted by the Bank of England and the European Banking Authority were positive as banks performed well overall with improved aggregate, stressed core equity tier one and leverage ratios, reflecting continued capital accumulation. This denotes the strength and resilience of UK and European banks and the banking sector.

In terms of fundamentals, we are heading towards the end of the third-quarter earnings season and the results, for both banks and insurance companies, generally continue to show good progress in the multi-year process of capital strengthening; this is obviously very supportive for subordinated debt holders.

Paradoxically, and despite the ongoing improvement in credit metrics, the spreads of subordinated debt have widened by more than 250 bps year-to-date. The income offered by our portfolio continues to provide an attractive return and the fund is well positioned for an environment of somewhat higher rates, owning many fixed-to-floater bonds and some discounted floating-rate notes, as well as a number of high-coupon securities with relatively short issuer call dates.

EUR

The ‘risk-off’ sentiment we experienced in markets in October continued during the month of November as there have been more headlines related to Brexit, the Italian budget and trade wars.

The fund was not immune to this, as reflected by its negative performance month-to-date. While the fund captured approximately 0.4% of income returns during the month, the prices of securities held in the portfolio declined on average by approximately 3.8%. These price movements appear to us to be extreme and do not reflect the strong quality of issuers held in the portfolio, some of which have seen rating upgrades during the month. Examples of what we perceived to be extraordinary value include the euro-denominated contingent capital liabilities of 5.25% HSBC trading at just 100.6, despite a call option and interest reset in September 2022 at 4.385% over the five-year interest rate, and 4.75% Banco Santander bonds now trading at 81.5, giving a yield to call in March 2022 of 9.1% or else it gets refixed at 4.097 basis points above five-year rates.

It is important to keep in mind that what drives the performance of the fund over time is the credit quality of the issuers we hold, combined with the steady and predictable income that we capture from their bonds. Prices can drop because of negative sentiment, but as the underlying credit quality has not changed, prices should recover once the dust settles.

As at the beginning of December, there potentially seems to be more constructive news regarding Italy and trade wars. The stress tests conducted by both the Bank of England and the European Banking Authority were positive as banks performed well overall with an improved aggregate, stressed core equity tier one ratio and a leverage ratio which reflects continued capital accumulation. This denotes the strength and resilience of UK and European banks and the banking sector. During the month, Royal Bank of Scotland took the opportunity to call a number of legacy capital securities, despite the fact they still had capital value.

In terms of fundamentals, we are heading towards the end of the third-quarter earnings season and have been seeing a confirmation of the secular theme of further equity build-up, balance sheet strengthening and deleveraging from the financial sector, which is obviously very supportive for subordinated debt holders. Paradoxically, and despite the ongoing improvement in credit metrics, the spreads of subordinated debt instruments have widened by more than 250 bps year-to-date.

GBP

The ‘risk-off’ sentiment we experienced in markets in October continued during the month of November as there have been more headlines related to Brexit, the Italian budget and trade wars.

The prices of the securities held in the portfolio declined on average by approximately 2.1% despite a lower 10-year gilt yield, where the rate had declined from 1.44% to 1.39%, and income generated by the fund of 0.5%. This is more extreme than in October and does not reflect the strong quality of issuers in the portfolio.

Obviously, we would prefer to see the prices of our securities going up. However, what drives the performance of the fund over time is the credit quality of the issuers that we hold, combined with the steady and predictable income that we capture from their bonds. Prices can drop because of negative sentiment related to Brexit concerns, but as the underlying credit quality has not changed, prices should recover once the dust settles.

As at the beginning of December, there potentially seems to be more constructive news regarding both Italy and trade wars. The stress tests conducted by the Bank of England and the European Banking Authority were positive as banks performed well overall with improved aggregate, stressed core equity tier one and leverage ratios, reflecting continued capital accumulation. This denotes the strength and resilience of UK and European banks and the banking sector.

During the month, Royal Bank of Scotland took the opportunity to call a number of legacy capital securities, despite the fact that they still had capital value. In terms of fundamentals, we are heading towards the end of the third-quarter earnings season and have been seeing a confirmation of the secular themes of further equity build-up, balance sheet strengthening and deleveraging from the financial sector, which is obviously very supportive for subordinated debt holders. This is not yet to be observed in the prices of the securities where the relatively new 5.875% HSBC, with a call and interest reset in September 2026 of 4.276% above five-year swap rates, declined in price from 99.1% to 98.1%.

Paradoxically, and despite the ongoing improvement in credit metrics, the spreads of subordinated debt instruments have widened significantly year-to-date; we therefore currently have a yield to maturity of 5.7%, including lower-yielding floating-rate notes. Income will be a strong driver of performance going forward. We also expect to eventually benefit from some capital gains.