German 10-year government bonds closed May at 0.34%, a drop of 22 basis points compared to the end of April. In May, the spread on the investment grade corporate bond index widened by 29 basis points to 132 basis points above the government bond curve. The index earned an absolute return of -0.26%. The spread on the High Yield (BB) index widened by 41 basis points, resulting in an absolute return of -1.12%.

Italian politics dominated the yield markets in May. The Italian general election in March this year was won by the populist parties: the Five Star Movement led by Luigi di Maio and the Lega Nord led by Matteo Salvini. Although there are huge differences in their manifestos, they did ultimately initiate negotiations. This was the only remaining option for forming a government. Together they hold a small majority in parliament, as well as sharing criticism of Eurozone policies. Markets responded nervously to comments about the euro. Bond spreads widened, including in other peripheral EU countries. The two parties finally agreed a governing manifesto that includes tax reforms to create two tax brackets of 15% and 20%, the scrapping of pension reforms, a minimum wage and a fierce anti-immigration policy but nothing on an exit from the Eurozone. These policies will create a higher budgetary deficit, but the parties seem more than willing to stand up to the EU on this. This increased uncertainty on the financial markets, which was later exacerbated when the parties absolutely insisted on Savona, an ‘anti-euro’ professor, as Minister of Finance. President Matarella felt the pressure from the markets and rejected the plan. Markets initially responded with relief, but this was of short duration. Market confidence deteriorated due to panic about the prospect of fresh elections. Volatility reached an interim high on Tuesday 29 May. On the bond market, trade in peripheral EU bonds and many credits ground to a complete halt. In Italy, the parties returned to the negotiating table and finally reached agreement. The new government will be headed by Guiseppe Conte, a law professor with no political experience, with Professor Giovanni Tria holding the portfolio for Economics and Finance. President Matarella approved the list of government ministers.

Spreads on corporate bonds quickly widened as a result of the increased risk aversion, especially those on bonds issued by Italian companies and subordinated bonds issued by banks and insurers. Moreover, there was a general widening of spreads on bonds that are eligible for the ECB’s CSPP programme. Spread curves also steepened.

For the first time in ages, a number of bond issues were cancelled due to a lack of demand from the market. Both German media company Bertelsmann and US white goods manufacturer Whirlpool were forced to cancel new bond issues. This was in spite of the fact that the spreads they were willing to pay represented a significant premium compared to where their existing bonds were trading.

May was a negative month for the Kempen Income Fund. The portfolio earned a return of -1.69%. The greatest movement was in spreads on peripheral EU government bonds and on corporate and high yield bonds. The fund’s positions in Italy, Spain, Greece, Portugal, Ireland and Slovenia yielded a negative contribution of 75 bps. The fund’s exposure to investment grade corporate bonds and high yield bonds made a negative contribution of 82 bps. However, our underweight in France yielded over 10 basis points, and our positions in Swedish krona and Norwegian krone also generated a number of basis points.

At individual company level, positive contributions came from the overweights in Becton Dickinson, Christian Dior, WPP, Huntsman, Ineos en Daimler, as well as the underweights in Generali, Telecom Italia, Tesco and Enel. Our overweights in Leonardo, Schaeffler and Orano, as well as our underweights in K+S, Caixabank, EDF, Terna, Allianz and Ceconomy, contributed negatively.