In July, the spread of the iBoxx Euro Corporate Index tightened by 8 basis points to 103 basis points above the government bond curve. The index earned an absolute return of 0.78%. German 10-year government bond yields closed July up at 0.54%, 7 basis points higher than at the end of June.

The positive sentiment on the credit market was chiefly driven by three developments in July.

Firstly, the relatively solid corporate results over the second quarter have further calmed investors’ concerns about the trend in creditworthiness at companies. At banks, for instance, the recovering European economy is causing a decrease in the provisions they need to make for bad loans and at the same time supporting demand for banking services. This is positive for their income from commissions. The stronger European economy and strengthening conviction about the tenability of the European currency union have also triggered an upturn on the secondary market for bad loans, allowing banks in the peripheral EU countries in particular to clean up their balance sheets more quickly. Non-financial institutions are also profiting from the pick-up in economic growth, but also from the specific recovery in sectors that were under severe pressure until very recently, including the oil & gas, mining and agricultural sectors.

Secondly, Mario Draghi has reassured the markets that an accelerated tapering of the ECB’s bond-buying programme is not imminent. In his speech on 20 July, Draghi stressed that a highly-expansionary monetary policy is still needed for the time being in order to achieve the long-term 2% inflation target. In doing so, Draghi moderated the comments he made in June, when he indicated that deflationary forces in Europe were being replaced by reflationary ones. Despite no official confirmation from the ECB, , it looks as if its programme to buy corporate bonds, the Corporate Sector Purchase Programme (CSPP), has not been reduced proportionally in line with the tapering of the QE programme since April of this year.

The final positive development on the market was the very small number of new corporate bonds issued. In July the supply of new bonds was EUR20.2 billion, i.e. down by about 62% on June and by 17% compared to July 2016. Non-financial sector institutions issued EUR13.0 billion in new bonds last month, while financial sector institutions issued EUR7.2 billion in new bonds. During the first seven months of this year, the supply of new bonds amounted to EUR341.9 billion, a slight drop of 5% compared to last year.

Across the month, the portfolio’s sensitivity to market trends varied between 110% and 118%. The portfolio therefore held an overweight positioning in terms of market risk.

Our positioning in the utility, industrial goods and telecom sectors performed relatively well in July. In contrast, our positioning in the non-banking financial services, personal household goods and energy sectors contributed negatively. Our liquidity position (in the shape of cash and government bonds) also contributed negatively.

At company level, a positive contribution came from the overweights in AT&T, CTE, Allianz and Partner Re and from the underweight in Daimler. Conversely, the underweights in Groupama and Credit Mutuel and the overweights in Volkswagen and Schaeffler contributed negatively.

Our pair trades contributed slightly positive, in particular the long position in International Game Technology versus the short position in Casino and the long position in Air Liquide versus the short position in BMW. The long position in Imperial Brands versus the short position in Volvo contributed negatively. The positive basis trades in Simon Property Group and Glencore contributed negatively. At the end of July, the global exposure of the Fund was 126%.

In July, the Fund participated in new bond issues by Nationwide Building Society (subordinated), Unilever, ALD, Steinhoff, National Grid, Sodexho, ADO Properties and Atlantia.

Outlook
Indices that measure volatility have fallen to their lowest levels in ten years. The corporate bond market is also experiencing extremely low volatility. This is in spite of a variety of risks, including: 1) tightening monetary policy (including interest rate hikes in the US and a reduction in the size of the Fed’s balance sheet; potential further tapering of the ECB’s bond-buying programme) which could have a negative impact on future economic growth; 2) growing pressure from activist shareholders on management teams to take steps to create shareholder value in the short term which could in fact weaken companies’ creditworthiness and ability to innovate in the long term; 3) the rapid rise of new technologies that could undermine existing business models in e.g. the retail, auto and energy sectors; and 4) a steady decline in the capacity of the West to safeguard geopolitical stability and security in the world and the erosion of consensus on the benefits of free trade and multilateral cooperation.

We are concerned about the discrepancy between the risks outlined above and the lack of volatility in the market. The historically less attractive spreads and the small amount of dispersion currently present in spread premiums that companies with wide-ranging levels of creditworthiness are having to pay in order to finance their activities are also causes for concern. For this reason, in spite of the improving economic climate in Europe and the persisting support for the credit market deriving from the ECB’s CSPP, we plan to maintain our relatively conservative positioning in the short term.