New Capital Fund Lux - EUR Shield

31 March 2024

Marketing Communication | Quarterly Commentary

Executive Summary

Key events in market

The European Central Bank cut its growth and inflation estimates at its March meeting, where Christine Lagarde's wording seemed consistent with a closer initial rate cut. EUR IG corporates delivered positive performance: 1-3y bucket (the Fund’s reference market) returned 0.58%, with better performance for longer maturities (+1.19% for all maturities index).

Key performance & positioning updates

At the end of the month, the Fund delivered a positive return of +0.59%, consistent with the reference index (ICE BofAML 1-3 Year Euro Corporate). The Fund ended March with A- rating, 3.75% yield, modified duration at 1.97 years (vs. 1.85 years of the index).

Market Update

The rally of global equity markets continued in March. The MSCI World index posted a monthly gain of 3%, bringing performance in the first quarter of 2024 to 8.5%. Interestingly, the month saw a rotation in market leadership from large technological companies to financials and small caps. In fixed income, government bond yields were little changed and corporate bond spreads tightened further. Despite the US dollar rising moderately against the major currencies, this was no obstacle to a new record high for the price of gold. The last few weeks were dominated by central bank activity. The Bank of Japan eventually terminated its negative interest rate and yield curve control policies and the Swiss National Bank unexpectedly cut interest rates. In contrast, the Federal Reserve, the European Central Bank and the Bank of England, among the major developed countries’ central banks, postponed the easing of monetary policy but signalled that interest rate cuts are likely in the near future. Accordingly, markets reacted positively focusing on the fact that financial conditions should become more accommodative rather than worrying about the uncertainty around the timing of such easing and the extent of future rate cuts. The outlook for US monetary policy has become less clear. Markets anticipate three rate cuts in 2024, but Chairman Powell kept all options open noting resilient economic growth and sticky inflation. The possibility that the Federal Reserve will cut rates later and by less than previously expected versus its peers cannot be ruled out. An improved growth outlook should eventually provide support to risky assets but carries the risk of increased short-term volatility as markets adjust to a less accommodative monetary policy. Hence, in view of the recent strong rally, only a moderate overweight in equities seems advisable along with a slight underweight exposure to fixed income assets. Keeping some cash available will allow for taking advantage of any temporary correction. As interest rates stay high, financials should perform better than most other sectors.

Fund Performance & Positioning

At the end of March, the Fund delivered a positive absolute return of +0.59%, consistent with the reference index. During the month, positive relative performance can be attributed to the overexposure to longest maturity bonds vs. the index and overweight in the financial sector. However, the lack of any subordinated financial bonds contributed negatively to the relative performance. In Financials we don’t hold any subordinated or US regional banks and we are well diversified across countries outside of Europe. The Fund holds exposure to 16 countries (the index holds 38 countries). In terms of weights, major overweight's versus the index are United States (+10.6%), Spain (+4.4%) and Italy (+4.3%). Major underweights are Netherlands (-6.9%) and France (-4.4%). There is no exposure to China, HK, Poland, UAE and other countries which are present in the benchmark. Looking at duration, the overall exposure is slightly higher than the reference index (+0.11y). This mainly comes from the exposure within US (+0.30y vs. index). From a sector point of view, we are keeping the overweight to a well-diversified group of senior financials (56% vs. 50%) while we are slightly underweight a few sectors such as basic materials, industrials, consumer non-cyclicals by 3% and communications, energy and utility by 2%. On ratings, we are overweighting the AA (+5.9%) and A (+3.6%) buckets, BBB stays at -9.3%. Overall the portfolio has an A- average rating (as the index), with a 3.75% yield and 1.97 years of duration. We think we are starting to see a normalization of the yield curve, that, given the multiplicative effect of the duration, is going to positively impact the slightly longer part of the curve. To be well placed for this movement, we are repositioning the portfolio with some longer duration. This has temporarily increased the absolute risk which is now in line with the benchmark (2.2% vs. 2.2%) but we believe the move is warranted. We are invested in 76 positions (vs. 1296 of the index) and continue to find enough opportunities in the Investment Grade market without having to consider emerging countries like Russia, China or even HY issues. Our defensive positioning allows us to avoid taking aggressive and volatile positioning such as low rated bonds (high yields) and/or very volatile ones (subordinated bonds). As a reference we have never been invested in Credit Suisse, China or real estate linked issuers. In terms of activity, following inflows we increased the allocation in the 1-3 bucket (T’26, BAC’26) and increased existing positions in the same bucket (JPM’28). The Fund has all Euro denominated issuers with no Forex exposure. In addition, the Fund is an Article 8 with 56.7% ESG score vs. 55.2% of the index.

	New Capital Fund Lux - EUR Shield	ICE BofAML 1-3 Year Euro Corporate Index	Difference
1 Month	-0.15%	-0.08%	-0.07%
3 Month	0%	+0.19%	-0.19%
6 Month	+2.27%	+2.64%	-0.37%
YTD	+0.05%	+0.47%	-0.42%
1Yr	+3.71%	+4.09%	-0.38%
3Yr Annualized	-	-	-
5Yr Annualized	-	-	-
Since inception annualized	+1.49%	+2.07%	-0.58%
Since inception 05.07.2022	+2.74%	+3.8%	-1.06%

Another tough month for the portfolio with both interest rate and spreads widening. Our now slight overweight vs. the benchmark (BofA ML 1-10 Yr Global Corporate Index), but underweight in duration vs. standard Investment Grade indices represented a drag on performance. Hedges helped modestly to offset a small proportion of overall exposure whilst providing a positive carry. The current position of long 5 year vs. short 10 year was a small drag in performance as US Treasury curve continued to invert, but is aligned with our forward looking view on the rate curve. Wider spreads were seen across regions and sector, however emerging markets and high yield spreads moved less than investment grade. Hence, double B and triple B rates issuers outperformed, namely Iceland, Jaguar and Pershing Square. Softbank also outperformed on the back of their tender. The portfolio’s exposure to Emerging Markets performed well, and credits in well insulated economies such as UAE and Peru. Developed market financials were a drag on performance during September, however spreads looked highly attractive vs. history and at peak levels compared to previous crisis. We continued to adjust the portfolio exposure to seek out relative value opportunities. In the financial sector, we were able to move from triple B 3 year bonds into single A 5 years bonds for same yield, thus positioning in a more favourable part of the curve, improving quality and improving potential total return on a relative basis. From a positioning perspective, the Fund has been reducing exposure to high yield and diversifying exposure to avoid idiosyncratic risks. Recently we added Iberdrola 12 year bond in replacement of single B and double B bonds like Coty and Mercado Libre. As at 30 Apr 2024.

Outlook

Monthly data published by the European Central Bank (ECB) show that the drag on spending from credit provision has decreased somewhat, although it remains large. The improvement, which is being seen more broadly across various economic indicators for the union, creates little urgency to reduce interest rates to support the economy. It seems likely that the ECB will wait until the middle of the year to cut and remain cautious afterward. Over the past months both headline and underlying inflation have been trending down. With the value-chain problems largely solved, energy prices remain stable or even somewhat weaker and import prices easing, there is more disinflation in the pipeline. However, at 3.1% yoy in February, core inflation remains clearly above readings consistent with the ECB’s 2% inflation target. Highly wage sensitive services inflation has remained close to 4% since November. Strong wage growth bears the risk of keeping underlying inflation stubbornly high. At 115bp, the OAS (Option Adjusted Spread) of the Euro corporate Aggregate is back to the level seen before the war in Ukraine. Corporate bonds do not appear as rich when compared to swaps. Swap spreads (swaps vs. government bonds) have collapsed, partly because the ECB has released parts of its bond holdings. High Yield spreads appear even richer than IG. IG spreads are likely to fluctuate around current levels in the coming months. With interest rates likely to plateau and high uncertainty around HY defaults, it makes sense to look to IG for the months to come, and European credit will be preferred over the US because of valuation considerations. As expected, activity on the primary market has continued to be strong and the investors are still very receptive to new issues, IG space (our reference market) leading the way. For that reason we’ll continue to actively join the primary market to find new opportunities, while remaining very selective (i.e. no real estate). Looking at the portfolio we will continue to follow our approach that aims to maximize diversification through a defined and repeatable investment process. Our proprietary risk tool is picking up a series of small idiosyncratic risks in the investment universe that we look to avoid, while we ensure we are better diversified on the primary risk factors. We continue to avoid subordinated bonds, low liquidity issuers and countries such as China. Regarding risk metrics we understand they can seem to be an important missing factor in our portfolio diversification, but we prefer to avoid those factors. We are focused on delivering a cautious approach, aware that over the short term we may miss some temporary opportunities. At the same time, we continuously screen our universe for the positions with the highest diversification potential to find new opportunities while always looking at the new issues on the market. Rising interest rates and tightening monetary conditions have resulted in the flattening of investment grade yield curves. That means investors can secure higher yields for shorter-dated maturities than for longer-dated ones, whilst reducing exposure to duration risk. This is crucial in a volatile and uncertain rate cycle. As a reference, in the last 10 years the yield spread between corporates 1-3y and 5-7y has been on average 60bps. Now, the 1-3y bucket yields 12bps more than the 5-7y one. We believe the portfolio is well positioned to capture the upside from stabilization in either a global negative or positive scenario by having a well-balanced exposure to credit, whilst being on a high potential position on the yield curve. We think the Fund, focusing on short-term high-quality investment grade universe, represents a product to be invested in for a number of reasons: embedded risk framework process (which aims to preserve capital), current yields levels (not seen since 2008), current yield shape and ECB monetary policy ahead. Lastly, the Fund can offer a potential solution for de-risking the asset allocation in portfolios by aiming to provide a repeatable and cautious approach to investing in the short term IG universe.

Fund Managers

Grazia Cozzi

Senior Portfolio Manager
Lugano

Fixed income

Detail

Sara Halm

Portfolio Manager
Lugano

Fixed income

Detail

Find out more

Disclaimer

MARKETING COMMUNICATION

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