In March, the spread on the ML Q964 Index tightened by 7 basis points to 218 basis points above the swap curve. The index earned an absolute return of +0.94% in March. German 10-year government bond yields closed March at -0.07%, a decline of 25 basis points compared to the end of February.

The sharp decrease in government bond yields in March was chiefly driven by a combination of worse-than-expected economic data and signals from central banks that they are planning to loosen monetary policy.

Economic growth figures continue to be worse than expected, especially in Europe. Indicators for industrial activity in particular have displayed a downward trend for several months now. In Germany, for instance, the PMI figures for industrial production in the first quarter of 2019 averaged 47.1. This is significantly lower than the average of 51.8 in the fourth quarter of 2018. Although economic growth remains positive in Germany, mainly thanks to robust consumer spending, the situation in Italy is rather alarming. Economic indicators there are pointing to a possible recession. It is worth noting that confidence among Italian businesses has already dropped to levels last seen in 2015.

In spite of the improved sentiment in the equity and corporate bond markets in the first two months of the year, the US central bank felt it was still necessary to convey an even stronger signal to investors that a further tightening of monetary policy is highly unlikely. The Fed will now stop reducing its balance sheet in September. Moreover, the Fed indicated that there would be no further interest rate hikes this year. The ECB has in turn announced a new TLTRO programme that allows banks to borrow from the central bank at very attractive rates. This will make banks, especially the smaller ones, less dependent on funding themselves in capital markets. At the same time, the ECB noted that it was aware of the negative impact that the extremely low interest rate environment is having on the profitability of the European banking system. The practical manner by which the ECB intends to boost the profitability of European banks remains unclear, however.

At the end of March, the number of bonds that make up the ML Q964 benchmark increased by one to 555, while the number of companies decreased slightly to 247. Additions to the benchmark included lower tier 2 bonds issued by Denmark’s Danske Bank and French bank Crédit Mutuel Arkéa, a lower tier 2 bond issued by reinsurer Swiss Re, a corporate hybrid bond issued by Telefonica and bonds issued by French companies Faurecia and Rexel. Bonds issued by French agricultural cooperative Tereos were removed from the benchmark after Fitch downgraded the company’s rating to B+, primarily due to persistently low sugar prices.

The amount of bonds issued by non-financial institutions in the European high yield market was EUR5.3 billion in March, about 21% down on last year. European high yield bonds totalling EUR11.6 billion were issued in the first three months of this year, a decrease of 43% compared to last year. This significant decrease in supply, combined with increased demand for high yield bonds, is
generating strong technical factors that have contributed to the sharp tightening of spreads seen in the first quarter of this year.

During the month, the portfolio’s sensitivity to market trends varied between 108% and 113%. The portfolio therefore held an overweight positioning in terms of market risk.

Our positioning in the industrial goods, auto and oil & gas sectors performed relatively well in March. In contrast, our positioning in the chemical, construction materials and basic resources sectors contributed negatively. Our liquidity position made a negative contribution.

At individual company level, positive contributions came from the overweights in Telecom Italia, DS Smith, Peugeot, Schaeffler and Leonardo, as well as from the underweights in Saipem and Netflix. In contrast, the overweights in Huntsman, Adler and Smurfit Kappa, as well as the underweights in Wind, Salini Impreglio and Worldpay, contributed negatively.

In March, the Fund participated in a new corporate hybrid bond issued by Telefonica and bond issues by Lincoln Finance (the holding company of Leaseplan), Schaeffler and Faurecia.

Outlook
The material tightening of spreads since the start of this year has led to a decrease in the number of interesting investment opportunities. Combined with our concerns about the slowdown in global economic growth, we will maintain our defensive positioning.