Sharing our convictions

Having fallen behind other markets in the post-COVID rally due to a lack of direct central bank support, we believe European ABS is set to outperform other parts of fixed income in the coming months as supply wanes and investors look to pick up on what we think could be a compelling relative value opportunity.

Barclays announced its results for the third quarter of 2020 this morning, with a number of media outlets opting to focus on a 6% year-on-year reduction in top-line income.

Charlie Munger, Warren Buffett’s brilliant partner, famously remarked that their investment approach was “simple, but not easy.” After nearly 40 years of investing, Portfolio Manager Ed Walczak explores how the Quality Growth team aims to overcome the many challenges investors face today in determining the “true” value of a company.

Many emerging markets are more resilient to external shocks than in the past and can better withstand the pressures of a stronger US dollar. And so far, many EMs have been fairly conservative in their use of stimulus in response to Covid-19. This increases the potential for prosperous times ahead.

Unlike the past six months, where nearly all new deals performed well in the secondary market, from here on in that is far from guaranteed. Expect winners and losers.

Corporate hybrids have evolved in recent years into a large and well-established asset class within the European fixed income market, with €185bn of bonds outstanding.

In this short video, TwentyFour CEO Mark Holman outlines what he expects to see from bond markets in the next few weeks, and explains why he thinks fiscal stimulus in the US can be the catalyst for the rally to resume in the medium term.

The press can have their sensational headlines, but these stories have little substance when it comes to the impact on the reputation risk of banks or indeed any significant impact on their balance sheets come May 2021.

One of the legacies of Europe’s post-crisis lending landscape was a huge retrenchment in risk appetite, amplified by a lack of bank capital and in some instances funding for an extended period of time.

With September set to be the first negative month for most risk asset markets since March, it is worth analysing what has been driving the reversal.

Overall CLO and loan performance have exceeded our expectations, though there are still plenty of headwinds for the market, chief among which is the prospect of further lockdowns and more economic disruption as Europe battles a second wave of COVID-19 cases.

Overall, in our view there may be some temporary volatility ahead which investors can try to sidestep or even take advantage of, but it’s probably not worth trying to be too cute as our medium term outlook is still constructive.

A cut by the Fed or the BoE from here would mean negative rates, while the ECB already has its deposit rate deeply negative at -0.5%.

The Bank’s ability to dampen market volatility has certainly been a comfort to fixed income investors; over the last month £ IG spreads have moved in a range of just 4bp and ended tighter than they started, which compares rather favourably to the 5% peak-to-trough swing in GBP-USD over the same period.

European collateralised loan obligations – or CLOs – are bonds issued to fund a specific and diverse pool of corporate loans to firms of different sizes and in different industries all over Europe.

The US government launches 2 new rules aimed at ESG and proxy voting. Individually they appear investor-first, but taken together may be seen as a political agenda to limit investor activism from social and environmental interest groups. We are concerned about the impact on effective stewardship.

There are still plenty of potential bumps in the road (Brexit, the US election, COVID-19 developments and so on) but the positive technical created by dwindling supply has the potential to push spreads tighter in coming months.

The ongoing trade war and eroding U.S.-China relationship have been a catalyst for making it less attractive for Chinese companies to seek a public listing in the United States. The Chinese government is finally making good on promises to open up domestic markets to foreign investors. Additionally, Hong Kong and China are taking steps to make local listings more attractive, especially to high-tech start-ups.

We expect September to be relatively busy with new ABS deals, but there’s a very strong technical developing in favour of ABS and CLOs, which should help performance in the coming months.

There are a number of countries in Europe where the banking sector remains very fragmented, and while a lot of work has been done in Spain with the mergers of multiple ‘cajas’ in the last few years, there is still scope for further consolidation.

If floating vs. fixed is no longer the most pressing question, then investors should be more focused on where they get the best credit spread.

The tweak that we will read so much about with respect to the inflation goal is that the new policy can be viewed as a “flexible form of inflation targeting”, meaning that following periods when inflation has been running below 2pc, appropriate monetary policy will likely aim to achieve inflation moderately above 2pc for some time.

Given most countries are going through the same issues and their fiscal expansions are justified, the relative value has not changed that much.

Yesterday we showed that for European investors, what we speculated on back in March has come true; that the bond market did recover its losses far more quickly than equities, as shown below.