Market Update: Corporate bonds

Our base-case scenario is that the economic impact of Covid-19 remains manageable. The China experience shows that it takes about 30 days for the number of positive cases to peak, and we have reason to believe that it will be similar in other areas. Therefore, we should be nearing the peak in locations outside of China. Hence, the impact should be contained to Q1 and the beginning of Q2. Growth in the US and Europe should remain positive. Supporting this view is the recent post-Covid-19 breakout forecast by the OECD, which continues to estimate positive economic growth globally (see chart).

Clearly, the virus has delivered the global supply chain a shock. However, there is anecdotal evidence that supply chains in China are recovering faster than expected, which should cushion the economic impact. For instance, Apple supplier “Foxconn” expects to return to normal operations by the end of March. Alibaba’s parcel and meal delivery arms have returned to “pre-Covid-19 virus outbreak” delivery levels. Actually, some of our Fixed Income team members have tested this by ordering from Alibaba platforms and orders are already on their way.

Governments and central banks are supporting the global economy by, for example, cutting rates by 50 bps outside of regular meetings (US Federal Reserve and Bank of England) and providing bridge business loans in China, Japan, and the UK to ensure corporates can finance working capital without disruption.

Further and significant relief is also underway, with European countries providing fiscal support. Spain has promised 18 billion euros, Italy 28 billion, the EU Commission 25 billion (with additions expected), the UK 30 billion, and France and Germany also expected to announce supportive measures. All in all, we are looking at packages of 150 billion euros and growing. This will amount to 1% of GDP in the European area, which is supportive of growth.

Recent actions we have taken

Vontobel Fund - EUR Corporate Bond Mid Yield

Since the beginning of the year, we have increased our exposure in longer-dated corporate bonds to reach circa 115 million (euro equivalent). These have outperformed the market and reference index in terms of total returns. Especially long-dated telecom and utility bonds (e.g., EDF and AT&T) are non-cyclical, less sensitive to global growth shocks than cyclical sectors, and can be considered “safe assets” in these turbulent times. In total, approximately 25% of the fund’s holdings are invested in “safe assets” and have supported performance year to date. We have refrained from selling any large exposure in credits, as we like their fundamentals and believe that spreads will reverse in due course. We follow our roadmap laid out and expect the negative market impact to be temporary.

Downside protection actions:

• We have increased the US Long Bond Future position (20-year) to nearly 7.5% of the fund in order to fully hedge our AT1 exposure.
• We have hedged our LT2 relative overweight with a temporary CDS overlay in ITRX EUR Sen Fin.
• Our government bond exposure has been increased to 7% and acts as a liquidity buffer
• Covered bonds constitute approximately 3% of the fund’s assets.
• Our current cash position, approximately 4%, is higher than in previous months and acts as a buffer in terms of spread widening.

Vontobel Fund - Global Corporate Bond Mid Yield

At the current levels, credit spreads start to look very attractive. We have seen spreads go from 100 bps to around 200. This is an extreme move and, in our view, overdone when looking at the fundamentals. With the recent wild moves we are seeing market dislocations opening up, which result in strong buying opportunities emerging, particularly for relative value trades. The fund is globally diversified, which should help in the current environment. We have reduced risk exposure where appropriate but kept issuers/bonds with good risk/return profiles. Furthermore, we have hedging strategies in place that are more cost efficient compared to outright bond selling.

Structural changes (since January)

• Increased exposure to non-cyclical sectors
• Overweight in utilities and telecommunications, underweighted in more cyclical sectors such as capital goods, energy, retail, and transportation.
• Reduced exposure to subordinated bonds and BB-rated bonds.

Temporary changes (since two weeks ago)

•     Implemented portfolio hedges using different instruments
  • The hedges we had in place behaved as expected
  • CDS iTraxx XOVER Protection (around 5%)
  • Increased the fund’s duration versus the reference index of around one year using US Treasury Bond Futures

Credit outlook

We have already seen, are seeing, and expect to see further coordinated action by global central banks to boost liquidity. The Fed has already cut 50 basis points outside of its regular meetings (as did the Bank of England). Further announcements are expected from the Fed, with another possible rate cut also likely.

We maintain that the coronavirus, while causing market disruption, is temporary and recovery is expected from the end of March. As we forecast normalcy and recovery, we are comfortable carrying on with our strategy. We have protected our funds well and did not downgrade our strategy more aggressively in line with our base-case scenario that spring will bring relief and that the US and European economies should still grow, albeit more modestly.

Credit markets are highly correlated with equity markets. If we look at the S&P 500, it is currently estimating negative 20% earnings growth, which, in our view, is way overdone. The silver lining is that the central banks will now calm the situation in the markets. This will augment liquidity tremendously with capital continuing to chase yield, especially since the US Treasury market no longer pays.

Current spread levels now offer us an enticing entry point with benchmark yields remaining depressed for an extended period of time following all the rate cuts. Therefore, we will carry on with our strategy, adhering to our road map, and will take advantage of the dislocations in the market.

 

 

 

FUND CHARACTERISTICS
Descrition	Vontobel Fund - EUR Corporate Bond Mid Yield EUR I LU0278087860
Index	ICE BofAML A-BBB Euro Corporate Index
Currency	EUR
Inception Date	13.07.2007
Time Period	13.07.2007 - 29.02.2020

Rolling 12-month net returns (in %)
	Fund	Index
28.02.2020 - 01.03.2019	7.6	5.5
28.02.2019 - 01.03.2018	-0.3	0.8
28.02.2018 - 01.03.2017	2.6	1.7
28.02.2017 - 01.03.2016	5.6	4.5
29.02.2016 - 01.03.2015	-2.4	-1.1

Past performance is no guide to future performance.
Performance data does not take account of commission or costs charged when units are issued or redeemed. Source: Vontobel Asset Management.

FUND CHARACTERISTICS
Descrition	Vontobel Fund - Global Corporate Bond Mid Yield USD I LU1395537134
Index	ICE BofAML Global Corporate Index Hedged USD (G0BC)
Currency	EUR
Inception Date	09.05.2016
Time Period	09.05.2016 - 29.02.2020

Rolling 12-month net returns (in %)
	Fund	Index
28.02.2020 - 01.03.2019	13.6	13.1
28.02.2019 - 01.03.2018	2.6	3.1
28.02.2018 - 01.03.2017	4.0	2.7
28.02.2017 - 01.03.2016	n/a	n/a
29.02.2016 - 01.03.2015	n/a	n/a

Past performance is no guide to future performance.
Performance data does not take account of commission or costs charged when units are issued or redeemed. Source: Vontobel Asset Management.