In July, the spread on the ML Q964 Index tightened by 33 basis points to 192 basis points above the swap curve. The index earned an absolute return of 1.57%. German 10-year government bond yields closed July at 0.44%, an increase of 14 basis points compared to the end of June.

The tightening of spreads in July was mainly driven by two factors. Firstly, corporate results over the second quarter were better than expected, especially for US companies. In addition to the recently implemented tax cuts, US companies continue to benefit from the solid economic growth in the most important regions of the world. However, pointing to the uncertain impact that protectionist measures and a potential hard Brexit could have on investments and trade, businesses are rather reluctant to extrapolate their recent performances in their guidance for the remainder of 2018.

The second factor that helped to tighten spreads was the limited number of corporate bonds issued in July, along with inflow into the high yield asset class. To prevent cash positions from becoming excessively large, institutional investors were relatively active in the secondary market.

Spreads on subordinated bonds issued by financial and non-financial institutions (the so-called hybrids) posted above-average performances in July. Bonds issued by Italian financial and non-financial companies also performed better than average. For instance, the spread on bonds issued by Italian telecom company Wind tightened by over 250 basis points after Hong Kong conglomerate CK Hutchison announced it was to pay EUR 2.45 billion to increase its stake in Wind from 50% to 100%. Within the individual rating categories of the high yield market, BB-rated companies outperformed the Bs and CCCs.

As of the end of July, 11 new bonds are to be included in the ML Q964 benchmark, primarily the result of new issues. These include two corporate hybrid bonds issued by Volkswagen with a total size of EUR2.75 billion, a EUR600 million bond issued by packaging material manufacturer Smurfit Kappa, as well as a EUR600 million bond issued by K+S, a German producer of salt and potassium.

New bonds issued by non-financial institutions in the European high yield segment amounted to EUR5.6 billion in July, down about 33% on last year. European high yield bonds worth EUR49.7 billion were issued by non-financial institutions in the first seven months of this year, a drop of 12% compared to last year.

During the month, the portfolio’s sensitivity to market trends varied between 104% and 113%. The portfolio therefore held a slight overweight positioning in terms of market risk.

Our positioning in the industrial goods, telecom and banking sectors performed relatively well in July. In contrast, our positioning in the media, utilities and healthcare sectors contributed negatively.. Our liquidity position had a negative impact.

At individual company level, positive contributions came from the overweights in K+S, Wind, Leonardo and Telefonica (hybrid bond), as well as the underweights in TDC, Nokia and Loxam. Our overweights in RWE Dea, Tank & Rast and TVO, along with the underweight in Generali, contributed negatively.

In July, the fund participated in new bond issues by Informa and K+S.

Outlook
We will maintain our conservative positioning for the time being. This positioning reflects our concerns about the trend for de-allocation from the broader credits asset class and the further tapering of the ECB’s CSPP programme later this year. At the same time, we continue to see opportunities in bonds issued by companies with improving credit profiles that may well see their ratings upgraded to investment grade.