In October, the spread on the ML Q964 Index widened by 36 basis points to 232 basis points above the swap curve. The index earned an absolute return of -0.78%. German 10-year government bond yields closed October at 0.38%, a decline of 9 basis points compared to the end of September.

A number of risks have preoccupied investors for some time now, such as the growing trade war between China and the US, the possibility of a hard Brexit, Italy’s high level of sovereign debt and the possibility of the US central bank implementing further interest rate hikes. It appeared to be therefore two different specific developments that contributed to the significant decrease in risk appetite in October compared to last month.

Firstly, third quarter corporate results in the US and Europe were worse than expected. Management teams attributed the worse-than-expected earnings and downward adjustments to guidance on a wide range of factors including higher costs for commodities-, transport- and labour, depreciating currencies in several emerging markets and slowing economic growth in Europe and China. Declining sales of new cars in China and Europe led not just to lower earnings for companies in the auto sector, but also to lower earnings at companies in adjacent sectors, such as chemicals and industrial goods.

In addition to the worse-than-expected corporate results, the second main development that contributed to weakness in the corporate bond market was the ongoing outflows from the asset class. The ECB’s relatively high use of its CSPP programme (EUR3.5 billion was bought in October) was unable to neutralise the negative impact stemming from these outflows.

In October, the number of bonds in the ML Q964 benchmark increased by eight to 563. The bonds added to the benchmark included two bonds issued by US media company Netflix with a total size of EUR2.4 billion, a EUR750 million bond issued by UK supermarket chain Tesco, two hybrid bonds with a total size of EUR2.5 billion issued by telecom company Vodafone and two bonds issued by Spanish supermarket chain DIA. Moody’s and S&P recently downgraded their ratings of the latter company to Ba2 and BB-, respectively. Both ratings were left on review for further downgrade. The number of companies in our investment universe increased by 12 to 255.

Bonds issued by non-financial institutions in the European high yield market amounted to EUR4.5 billion in October, down about 72% on last year. European high yield bonds worth EUR62.7 billion were issued by non-financial institutions in the first ten months of this year, a decrease of 25% compared to last year.

Across the month, the portfolio’s sensitivity to market trends varied between 103% and 107%. The portfolio therefore held a slight overweight positioning in terms of market risk.

Our positioning in the retail, telecom and utilities sectors performed relatively well in October. In contrast, our positioning in the industrial goods, leisure and food sectors contributed negatively. Our liquidity position made a positive contribution.

At individual company level, positive contributions came from the overweights in Tesco, TVO and Ineos, as well as the underweights in Telecom Italia, LKQ, Grupo Antolin and Jaguar Land Rover. In contrast, the overweights in Volvo Cars, Huntsman, Schaeffler, DS Smith and Avis contributed negatively.

In October, the Fund participated in new bond issues by Tesco, CaixaBank and Playtech.

Outlook
We will maintain our conservative positioning for the time being. Our conservative positioning reflects our concerns about the trend for de-allocation from the general 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 see their ratings upgraded to investment grade.