In September, the spread on the ML Q964 Index tightened by 10 basis points to 196 basis points above the swap curve. The index earned an absolute return of 0.35%. German 10-year government bond yields closed September at 0.47%, an increase of 15 basis points compared to the end of August.

Ongoing concerns about the economic impact of a potential hard Brexit, burgeoning trade wars between the US and its major trade partners and uncertainty about the budgetary discipline of the new Italian government had a negligible impact on sentiment in the capital markets. Combined with the imminent further tapering of the ECB’s bond-buying programme, the increase in investor risk appetite contributed to the higher German 10-year government bond yields.

Company-specific trends dominated the high yield market in September. Bonds issued by companies whose credit ratings were upgraded performed particularly well. For instance, car manufacturer FiatChrysler moved a step closer to an investment grade rating when Moody’s upgraded its rating to Ba2 with a positive outlook. Swiss chocolate manufacturer Barry Callebaut did receive an investment grade rating of Baa3 from Moody’s and this contributed to a spread tightening of 20-30 basis points on the company’s bonds. Sentiment about French supermarket chain Casino benefited from rumours of a potential takeover by sector peer Carrefour. September also saw a limited recovery in spreads on bonds issued by companies with an above-average dependence on emerging markets, including Spanish telecom company Telefonica.

The dispersion within the general high yield market increased sharply in September. The prices of bonds issued by several companies with a B rating or lower dropped considerably. Corporate bonds with a BB rating, i.e. higher-quality bonds, displayed significantly better results than those issued by companies with lower ratings. Furthermore, the trend of outflow from the high yield market seems to have come to an end. Higher effective yields and spreads are apparently again tempting investors back into the asset class.

At the end of the month, sentiment towards Italian financial institutions suddenly turned negative when the Italian government presented a disappointing budget for 2019. The planned budget deficit of -2.4%, coupled with policy proposals that could adversely affect the competitiveness of the Italian economy, triggered a negative response on the bond market. Italian 10-year government bond yields shot up by nearly 26 basis points in a single day, and the spread against Germany widened to 267 basis points.

The number of bonds that make up the ML Q964 benchmark remained stable in September. Those bonds added to the benchmark include two EUR500 million subordinated lower Tier 2 bonds issued by French insurer Groupama and UK insurer Phoenix Group, a EUR300 million bond issued by the Swedish manufacturer of camping and sailing accessories Dometic, a EUR700 million hybrid bond issued by Belgian electricity grid operator Elia and a EUR500 million bond issued by UK car manufacturer Jaguar Land Rover.

New bonds issued by non-financial institutions in the European high yield segment amounted to EUR7.3 billion in September, a decline of about 38% compared to the year-earlier period. European high yield bonds worth EUR58.2 billion were issued by non-financial institutions in the first nine months of this year, a drop of 15% compared to the same period last year.

During the month, the portfolio’s sensitivity to market trends varied between 105% and 111%. The portfolio therefore held a slight overweight positioning in terms of market risk.

Our positioning in the auto, industrial goods and telecom sectors performed relatively well in September. In contrast, our positioning in the retail, media and utilities sectors contributed negatively. Our liquidity position made a negative contribution.

At individual company level, positive contributions came from the overweights in Telefonica, FiatChrysler, Schaeffler and Smurfit Kappa, as well as from the underweights in Salini Impreglio and Jaguar Land Rover. Our overweights in Casino, Orano, Adler, RWE Dea and Tank & Rast contributed negatively to the return.

In September, the Fund participated in new bonds issued by FCA Bank, Phoenix Group, EDF, Dometic, Avis and El Corte Inglés.

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 well see their ratings upgraded to investment grade.