German 10-year government bond yields closed November at 0.31%, a decline of 7 basis points compared to the end of October. It is nearly two years since we last saw German bond yields at this level. The spread on the index for investment grade corporate bonds widened by 21 basis points to 166 basis points above the government bond curve. The index earned an absolute return of -0.66%. The spread on the High Yield (BB) index widened by 46 basis points, resulting in an absolute return of -1.5%.
Last month’s negative sentiment on the European corporate bond market deteriorated further in November. Investors seem to prefer the safest investments, including German and US government bonds and cash.
Many of the themes that have triggered instability this year, such as Italy, the Brexit and the trade war, flared up again this month. The European Commission rejected Italy’s budget in mid-November and subsequently advised ECOFIN to initiate infringement proceedings against the country. This caused Italian spreads to widen even further. Later in November, however, the tone of discussions between Italy and the EU became slightly more constructive. It looks as if policymakers are prepared to reduce the budget deficit from 2.4% to 2.0% in 2019, but agreement has not yet been reached.

Progress was also made on the UK’s exit from the European Union (EU). Prime Minister May negotiated a Brexit agreement with the EU and all the EU countries agreed to it. The next step is a vote on the agreement in the UK parliament. This will be a much tougher task as there does not appear to be a majority in favour of it.

In addition, oil prices noted a sharp drop of over 20% in November. This can chiefly be attributed to events relating to supply. OPEC may cut production to stabilise prices at a higher level.

A number of trends also affected the corporate bond market specifically this month: the deteriorating creditworthiness of companies caused by a combination of growing debt positions, lower profitability and decreasing diversification due to the dismantling of conglomerate structures; the end of the ECB’s bond-buying programme; and the persisting de-allocation from the corporate bond asset class.

November was a negative month for the Kempen Income Fund. The portfolio earned a return of -0.61%. With the exception of Italian government bonds, differences in yield between Germany and the other Eurozone countries widened in November. The spread on Italian 10-year government bonds tightened by 15 basis points, while spreads on other countries widened by a few basis points. We hold a small overweight in Italy, but larger overweights in Spain, Ireland, Slovenia and Portugal. Our overweights in these government bonds therefore contributed negatively to the relative performance.

At individual company level, positive contributions came from the overweights in Atos, Takeda, Pharmaceutical, ING, Becton Dickinson Tesco, RWE DEA and DS Smith, as well as from the underweights in Daimler, Banco Santander, HSBC, Telecom Italia, Jaguar Land Rover, Grupo Antolin and thyssenkrupp. In contrast, the overweights in General Electric, Telefonica, OMV, Colfax, Volkswagen, Samvardhana Motherson and Aroundtown made a negative contribution.