In January, the spread on the ML Q964 index tightened by 42 basis points to 259 basis points above the swap curve. The index earned an absolute return of +2.06% in January, its best month in nearly three years. German 10-year government bond yields closed January at 0.15%, 9 basis points lower than at the end of December.

There are increasing signs that global economic growth is weakening, particularly in Europe and in China. Examples include the economic recession in Italy, the falling IFO business climate index in Germany and Chinese car sales that in December were down 16% compared to the year earlier period. A multitude of factors seems to be responsible for the slowdown in growth, including the uncertainty surrounding Brexit, the difficult trade relations between the US and China and the impact of monetary tightening.

In spite of the deteriorating economic conditions, sentiment on the European corporate bond market underwent an almost total reversal from the negativity that dominated the fourth quarter of 2018. This U-turn in investor sentiment seems to be mainly driven by expectations that the US central bank will pursue a much less aggressive monetary policy in 2019 than had initially been feared. In December last year, Fed chairman Jay Powell claimed that the reduction in the Fed’s balance sheet was on automatic pilot and that further gradual increases in interest rates were likely. Yet Powell adopted a more nuanced tone in January. The Fed now intends to be patient on further interest rate hikes and the reduction of the balance sheet will now depend on how economic data evolve.

Subordinated bonds issued by insurers and non-financial companies performed better than average in January. BB-rated bonds also outperformed high yield bonds with lower ratings.

As of the end of January, the number of bonds that make up the ML Q964 benchmark increased by 5 to 554 and the number of companies increased to 251. Bonds added to the benchmark included a EUR500 million corporate hybrid issued by French hotel group Accor, a EUR500 million lower tier 2 bond issued by Italian insurer Generali and a EUR1.25 billion senior unsecured bond issued by Telecom Italia. Italian scooter and motorcycle manufacturer Piaggio has entered the benchmark after Moody’s upgraded its rating to Ba3 with a stable outlook.

The number of new bond issues by non-financial institutions in the European high yield market amounted to EUR3.5 billion in January, about 44% down on last year.

During the month, the portfolio’s sensitivity to market trends varied between 101% and 110%. The portfolio therefore held an overweight positioning in terms of market risk.

Our positioning in the banking, technology and telecom sectors performed relatively well in January. In contrast, our positioning in the basic resources, food & beverage and media sectors contributed negatively. Our liquidity position also made a negative contribution.

At individual company level, positive contributions came from the overweights in Nokia, Solvay, EDF, Adler and Motherson, as well as from the underweights in Ceconomy, Jaguar LandRover, Wind and Gestamp. In contrast, the overweights in Schaeffler, FCA Capital, thyssenkrupp, as well as the underweights in Contourglobal and Spie, contributed negatively.

In January, the fund participated in new bonds issued by Telecom Italia and Smurfit Kappa.

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 the multiple signs of a slowdown in global economic growth and our forecast that the supply of new bonds will increase significantly in the next few months as a result of the attractive rates at which companies can obtain funding, we have decided to reduce the level of risk in the portfolio.