12 June 2023

Fixed Income Monthly Comments - May 2023

RAM Global Bond Total Return

Reduced premium
Financial markets experienced diverse fortunes during the month, with European rates, which previously underperformed, declining supported by improving inflation figures, while US rates moved slightly up on the Debt Ceiling agreement. Spreads stayed relatively stable, ending the month at relatively tight levels.

The conclusion of the Debt Ceiling narrative is expected to occur in early June with an agreement to increase it, similar to previous episodes. Market expectations of this outcome have already been priced in during the latter half of May, leading to a rally in Equities and Credit, thereby reducing the risk premium in both. However, this comes at a time when markets are likely to face significant liquidity withdrawal as US Treasury needs to replenish its cash balance by issuing a substantial amount of T-Bills.

In recent months, there has been a lot of hype surrounding AI, which undoubtedly represents a significant innovation. Alongside this, the service sector remains resilient, and the unemployment rate remains low, fostering a sentiment of an ongoing and never-ending economic cycle. However, upon closer examination, the S&P 500 Equally-Weighted Index has remained relatively flat this year, lagging behind the float-weighted S&P 500 Index by approximately 10 percentage points. This highlights the current challenging earnings landscape, which has been exacerbated by the recent sharp monetary tightening measures implemented by central banks over the past 12 months.

To mitigate any potential funding stress, we have shifted some of our EUR duration from swaps to liquid high-quality agencies. Additionally, towards the end of the month, we took advantage of the cheapening of UK markets compared to Europe and reallocated some EUR duration into UK Gilts, where tightening expectations are elevated. As Credit spreads tightened towards the year lows around the Debt Ceiling, we decided to book partial profits on long Credit exposures expressed via short protection on CDS Indices, taking advantage of the liquidity offered by these instruments for tactical moves. Overall, our portfolio maintains a high-grade bias, with a 7% exposure to high yield. Our traditional portfolio delivered -0.36% (gross of fees).

As a precautionary measure with the Debt Ceiling looming, we decided to book profits on some of our long 3-year UST against swaps early in the month. We have maintained our long 10-year positions against 30-year positions in both Europe and the US to express our view on the end of the tightening cycle in these regions. Our non-traditional portfolio delivered +0.04% (gross of fees).

As USD rebounded during the second half of the month, SEK underperformed, and the BRL experienced some correction. Our FX exposures, which are diversified and limited in size, remained unchanged this month. Our FX portfolio delivered -0.09% (gross of fees).

At the end of the month, the RAM (Lux) Tactical Funds – Global Bond Total Return Fund (Class B USD) delivered -0.54% net of fees. The duration stood at 3.3 years and the average Credit quality was AA-. 


RAM Asia Bond Total Return

Asia Credit: The Rise of The Debt Ceiling?

As May rolled along, we found ourselves closer and closer to the final détente possibly of this iterations Debt Ceiling dance. The positive headlines about the Debt Ceiling bill passing led to a risk rally into month-end. Whilst Chinese data, was weak over the month the global data has not shown widespread deterioration of economic activity many have been forecasting. June will likely be driven by the Debt Ceiling, data and the FOMC.  

Banking concerns still lingered, inflation remained sticky and economic data mixed again in May. Risk assets again showed some resiliency; Equities and Credit spreads inched further or were close to unchanged from the strong previous month-end. Global bond yields went higher over the month, but Chinese and Hong Kong Equities underperformed on the poor Chinese data.  The market in Asia credit managed to outperform global peers (Markit iBoxx USD Asia ex-Japan index was +1 bps vs. US IG which was +5 bps). The total return in Asia credit was driven by interest rates (duration) with total return negative due to the UST sell-off. The Asian primary market was steadier with an Asia ex-Japan bond supply of USD 9.6 BN (USD 6.9 BN in April 2023 and USD 13.0 BN in May 2022). YTD Asia ex-Japan supply is down -40% YoY. 

Outlook and portfolio performance
On spread levels, the relative value is less compelling in Asia Credit and the trajectory in the China property sector appears to have moved more in bonds rather than follow through on policy. As ever, developments in China policy will be a key driver of opportunities. We remain cautious in China due to the policy uncertainty but recognise that the worst is likely behind us. 

We are also less concerned compared to our peers with coupon certainty (which has driven duration buying). For now, we do not subscribe to the view shown in the rates market inversion and choose to remain underweight duration focusing on receiving similar yields in the front end versus the long end. We believe that rates may stay higher for longer and for now coupon replacement risk is not a significant concern. 

We started the year defensively positioned in duration and China property due to the continued uncertainty in the China property sector and what we saw as better yields in the front-end. Whilst some tailwinds have receded, the hawkish stance of the FED is misinterpreted, and we think that the risk of a BoJ pivot is growing (Japan corporates are announcing wage increases across the board being an example) which keeps us conservative. Hence, we still believe a defensive portfolio construction to be the appropriate stance. The wrinkle of the inversion of the UST curve which is leading to flat yield curves in Credit bonds is a driver also for this.

The RAM (Lux) Tactical Funds II - Asia Bond Total Return Fund (Class PI USD) fund was down -0.5% in May, outperforming the JACI by 0.5%. The fund has returned +2.3% YTD vs. JACI at +2.5%. The fund remains well diversified. We remain very flexibly invested with a net duration of 3.0 years and 12% cash levels, and we would look to rotate out of cash and tightly traded Investment Grade bonds into new issues or HY on further market clarity and at some time add duration.


RAM Multi Asset Credit Strategy

May witnessed an increased in returns’ dispersion with many markets reversing April’s move. Credit space was among them with investment grade and high yield - in particular in the US - ending the month wider while EU Financials and Structured Credit outperformed. Macroeconomic data continued to impress, highlighting the resiliency of global underlying economies. In particular, the US appears to be handily outperforming other major economies, such as Europe and China. Markets continues to price growing expectations that inflation have peaked both in the US and in Europe and speculation that the global monetary tightening cycle is reaching its conclusion.  After embarking on the most aggressive hiking on record, Central Banks’ policy remains the main driver of financial markets’ performance. Inflation data throughout developed markets appears to have peaked and, while recession fears have grown, there is confidence that a hard landing can be avoided. 

As we near the end of a much-anticipated earnings season, with market participants looking for clues on how well corporate America is doing in the face of the recent US regional bank turmoil and concerns about a possible economic slowdown or recession. Thus far, with 92% of S&P 500 companies having reported, 77% have posted earnings that have beaten expectations, which is above the long-term average of 66% and prior fourth quarter of 73.5%. It is also the highest percentage of S&P 500 companies reporting a positive EPS surprise since the third quarter of 2021. It is worth noting that the above consensus results come on the back of tepid expectations given that analysts had slashed forecasts before the season kicked off. Despite the beat, earnings still posted negative year-over-year growth, falling by 3%, albeit better than the 7% drop expected at the beginning of the season following the recent downward revisions. While revenues remained positive with companies reporting top-line growth of roughly 4%, profitability appears to have suffered as sales growth outpaced earnings growth, suggesting a squeeze on corporate margins.     

During the month fund posted a positive performance with all asset classes posting positive performances. The portfolio continues to be cautiously positioned as well as we maintain a portion of our P&L hedged to mitigate against potential volatility coming from unexpected negative macro surprises. The portfolio managers have increased the level of liquidity to increased flexibility. Valuations remains very compelling in some Credit asset classes and selected themes are still interesting, particularly in Europe. The Fund focused on bonds with 8-9% yield and upside potential while the blended yield is now above 8% in EUR with BB+ average rating. At sector level we have been rotating into selected defensive BB rated credits and EU Tier 2 financials. We continue to think that BBB CLO tranches, yielding 8%, are an extremely attractive opportunity in the current market context. There were very few new issues to consider as some high quality names tapped to the primary market offering nice premiums versus secondary. The portfolio managers will continue to look for relative value switches from a bottom-up perspective.


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