In December, the spread on the iBoxx Euro Corporate Index tightened by 2 basis points to 100 basis points above the government bond curve and 72 basis points over de swap curve. The index earned an absolute return of +0.15%. German 10-year government bond yields closed December at -0.61%, representing a decrease of 4 basis points compared to the end of November.

In December we saw a further increase in negative COVID related headlines. The increase in infections in most western economies resulted in stricter lockdowns in most European countries and the US. Although these lockdowns will have a negative impact on the economic growth expectations for the months to come, the market continued to focus on the hope that the roll-out of the vaccination program will result in a normalization of economic activity in Q2. On the vaccine front there was positive news with most countries starting vaccination programs by the end of December, after vaccines of Pfizer/BioNTech were approved in the UK, EU and US. Also the Moderna vaccine has been approved in the US, and the UK was the first to approve the Oxford/AstraZeneca vaccine. This will result in a gradual increase in vaccinations in the months to come. New mutations of the virus had a temporary negative impact on markets due to the fear that this might increase the duration of lock-downs or result in lower vaccine efficacy rates. Despite the impact of the lock-downs on mainly the services sector, the manufacturing sectors continue to perform very well. This is largely driven by ongoing strong demand for consumption goods.

We expect a stronger and more permanent recovery later this year as bigger parts of the population will get the vaccine and social distancing measures will gradually be removed. The big question remains how quickly populations will be vaccinated particularly among vulnerable groups. If these groups can be vaccinated quickly that could pave the way for a gradual easing of restrictions. In some of the more advanced countries like the US and UK 1% of the population received the first dose. However, markets are likely to be closely watching any issues with Covid-19 or the vaccine rollout, not least given the new variants that have been found in the UK and South Africa which spread more rapidly and have been found in increasing numbers of countries.

On Christmas eve there was the announcement of an agreement made on the post Brexit trade deal between the UK and EU. This removed one of the tail risks for financial markets and averted the prospect of punitive tariffs and a chaotic non-deal split between the EU and the UK. Some issues are still far from settled and the agreement contains several review clauses that either side can periodically re-negotiate. Also little clarity is offered for financial firms and access for financial services will be the subject of discussion between the UK and EU in 2021.

In the US there was also agreement on a new Coid-19 relief package. On December 28 president Trump signed the stimulus bill into law that will release $ 900 billion in emergency relief funds into the US economy.

On the monetary front there was further positive news from the ECB. Last month the ECB announced a further extension of the PEPP program until March 2022 and an increase in size by € 500 billion. Also the APP continuous with € 20 billion per month. The earlier announced additional APP envelope of € 120 billion has been utilized. Taking into account the remaining PEPP and APP capacity the ECB will have ~ € 1.4 trillion of net buying capacity until the end of March 2022 and ~€ 1.1 trillion for 2021. This is more or less similar to what they did in 2020. The ECB did note that: "if favorable financing conditions can be maintained with asset purchase flows that do not exhaust the envelope over the net purchase horizon of the PEPP, the envelope need not be used in full." This creates some flexibility to scale down purchases when they are no longer needed, but central banks are likely to be rather safe than sorry and more willing to overshoot, especially in the context of weak inflation.

There was little news on the corporate front. The positive vaccine news and Brexit deal seemed largely priced in and did not move the market significantly. Despite the apparent good news on vaccines the most Covid exposed names underperformed a bit due to further restrictions being put in place.
During the month, bonds from companies operating in the automobiles & parts and basic resources sector slightly outperformed. Companies in the retail sector slightly underperformed. But overall the differences between sectors were very limited. Over the full year 2020 basic resources was the best performing sector with spreads tightening 16 bps whilst the oil & gas sector was the worst performing sector widening 31 bps. Overall corporate spreads were only 4 bps wider than at the start of the year.

The supply of new bonds in December was limited. Non-financials issued € 8.6 billion in new bonds. In financials the issuance was even lower with € 3 billion in new issues coming to the market. Given higher levels of redemptions the net supply in December was € 8 billion negative for both categories combined. Total gross supply for the corporate sector ended the year at € 441 billion. This was 49 billion higher compared to last year. Financial issuance was € 36 billion lower than last year with a total amount of € 232 billion issued in 2020. The lower financials supply was mainly as a result of TLTRO offerings by the ECB and high deposit inflow. The one segment that is clearly up compared to last year is the supply in corporate hybrids. This supply more than doubled since last year to € 42 billion as more companies looked to issue hybrid bonds to support their credit profiles.

During the month, the portfolio’s sensitivity to market trends varied between 105% and 110%. The portfolio therefore held an overweight positioning in terms of market risk.

Our positioning in telecommunications, infrastructure and chemicals performed relatively well in December. Our liquidity position, in the form of cash and government bonds, detracted from performance.

At individual company level, positive contributions came from the overweight in Total, Verizon and Telefonica. Our overweight in Abertis and Frankfurt Airport continued to benefit from the ongoing positive sentiment around infrastructure assets despite more lock downs being implemented hurting airport and toll road traffic.

In contrast, the underweights in General Electric and short maturity bonds of Bank of America contributed negatively.

In December the Fund did not participate in any new issues as they lacked new issue premiums due to strong demand.

Outlook
We remain mildly constructive on the market. Although we see the significant positive effect that a working vaccine will progressively have on the economy in the longer term, we do remain concerned on the near term economic growth expectations. We expect economic growth momentum to continue to be weak in the near term, but have a positive view on a 3-6 month horizon with a strong recovery expected in Q2. Companies remain very much bond holder focussed. This supports the fundamental quality. However after the rally in the 4th quarter of 2020 valuations are starting to look expensive. Finally, the technical backdrop still remains very robust as a result of the ECB’s willingness and ability to pump liquidity into the government and corporate bond markets and limited net supply.