In May, the spread on the ML Q964 Index widened by 41 basis points to 208 basis points above the swap curve. The index earned an absolute return of -1.12%. German 10-year government bond yields closed May at 0.34%, a decline of 22 basis points compared to the end of April.

Sentiment in the capital markets was primarily driven by events in Italy. It initially appeared as if the Lega Nord and Five Star Movement parties would form a government with policies aimed at partly reversing the austerity measures and pension reforms introduced by previous Italian governments. The stumbling block for forming this government proved to be the proposed appointment of Paolo Savona as
Minister of Finance. Past remarks by Savona on the need to prepare for exiting the euro should the currency become an obstacle to prosperity in Italy made markets very jittery. However, President Mattarella vetoed Savona’s appointment, citing the potential harm his appointment could cause to holders of Italian bonds and the Italian financial system as a whole. Markets subsequently panicked about the prospect of a fresh general election. The fear was that this election would act as a kind of unofficial referendum on Italy’s membership of the euro. With the unexpected results of the Brexit referendum and the recent US presidential election still fresh in their minds, risk aversion increased among investors. This was a major factor behind the sharp decrease in German 10-year government bond yields.

Spreads on corporate bonds quickly widened as a result of the increased risk aversion, especially those on bonds issued by Italian companies and subordinated bonds issued by banks and insurers.

As of the end of May, twelve new bonds are to be included in the ML Q964 benchmark, primarily the result of new bond issues. These include a EUR750 million corporate hybrid issued by La Poste in France and a EUR550 million corporate hybrid issued by the CPI Property Group, as well as a EUR250 million bond from Italian scooter and motorcycle manufacturer Piaggio.

New bonds issued by non-financial institutions in the European high yield market amounted to EUR5.4 billion in May, which is about 15% up on last year. European high yield bonds worth EUR37.4 billion were issued by non-financial institutions in the first five months of this year, a decrease of 3% compared to the same period last year. The market for non-financial companies with a BB rating, the core of our investment universe, continues to grow. Over the past few months, the amount of outstanding debt issued by these companies has risen by nearly 20%.

The portfolio earned a return of -1.14% and in doing so underperformed its benchmark, which lost -1.12%, by 2 basis points. During the month, the portfolio’s sensitivity to market trends varied between 102% and 108%. The portfolio therefore held a slight overweight positioning in terms of market risk.

Our positioning in the chemical, oil & gas and telecom sectors performed relatively well in May. In contrast, our positioning in the auto, industrial goods and technology sectors contributed negatively. Our liquidity position contributed positively.

At individual company level, positive contributions came from the overweights in Huntsman and Ineos, as well as the underweights in Generali, Telecom Italia and Tesco. Our overweights in Leonardo, Schaeffler and Orano, as well as our underweights in K+S and Ceconomy, contributed negatively to the return.

In May, the fund participated in a new senior bond issue by G4S and the corporate hybrid bond issued by the CPI Property Group.

Outlook
We will maintain our conservative positioning for the time being. This positioning reflects our concerns about the trend of de-allocation from the credits asset class and the further tapering of the ECB’s CSPP programme later this year.

Given the material widening of spreads since the start of this year and the steeper spread curves, we can now identify more interesting investment opportunities and we will use these to selectively add more risk to the portfolio.