Credit markets: a paradigm shift
After more than a decade of suppressed and often negative yields, the fixed income asset class has entered a higher rate context. While it is evident that bond markets are exhibiting higher levels of yield and providing some attractive entry points to lock in future performance, we also believe that they are facing a paradigm shift. Persistently elevated levels of inflation have not only led to a sharp increase in rates by monetary policy makers, but also the end of most quantitative easing programs and a significant reduction in central bank balance sheets. While inflation levels do appear to have peaked and are trending lower, we are still far away from the 2% target of most central banks. This implies that rates are likely to remain higher for longer. The fact that the lack of central bank support is taking place after over 12 years of monetary accommodation means that bond investors are facing a context of lower liquidity support and higher rates that they have not seen in a very long time. An ultra-hawkish monetary stance that openly seeks to combat inflation through demand destruction for "as long as it takes", will continue to drive a slowdown in the economy, and has already led to significant spikes in volatility, which show no signs of abating.
Adding to this complexity are certain structural trends that have taken form over the past few years and that are likely to have a considerable impact on rates. Geopolitical risk indeed is one such element that is expected to be a strong driver of current and future volatility. With the Russian invasion of Ukraine still showing no signs of resolution, the impact on inflation (namely energy prices) is likely to last for some time. The situation has a material impact on energy and food security across the globe as Russia and Ukraine are both major food exporters, while Russia is also a major exporter of fertilizers. These factors mean that the conflict is likely to put upward pressure on inflation and a downward one on growth.
Furthermore, the rise in populism and deglobalisation is a very noticeable trend across developed and emerging markets. The visible result of these trends is often a greater number of trade conflicts/wars, often resulting in greater protectionism and ultimately higher tariffs. This is also very likely to cause spikes in inflation, lead to lower growth and cause turbulence on markets.
Another trend that saw acceleration during the COVID period was decarbonation, as regulation and guidelines on greenhouse gas emissions continue to be reinforced considerably, challenging many sectors (ex: Autos). Some companies have needed to rethink their business models and structurally altered their day-to-day activities. This not only concerns issuers but also has a material impact on inflation and growth, thereby once again being a source of disruption in markets.
All in all, these structural trends are likely to lead to high levels of inflation and lower growth. This, combined with lower monetary support, weak levels of liquidity, and credit contraction should usher in greater idiosyncratic risk within corporate bond markets. These are exhibiting an increasingly asymmetric profile, with much greater downside risk. This is going to result in higher dispersion amongst segments as well and heightened volatility across markets which is likely to be a source of challenge for bond investors.
In the middle of difficulty lies opportunity
In such a context, for investors who wish - or have - to be invested in credit market, we believe an absolute return approach to be a viable solution.
Candriam Bonds Credit Alpha fund invests most of its assets in corporate bond securities (including corporate subordinated debt for a maximum of 40% of net assets) from issuers located in developed countries whose rating given by one of the recognized rating agencies is greater than or equal to CCC /Caa2 (or equivalent) or considered of equivalent quality by our internal credit analysis. The credit alpha strategy is a pure long / short credit strategy with no bias that employs a high conviction, selective approach designed to deliver uncorrelated performance across all market conditions. The fund focusses on detailed bottom-up ESG-integrated research, allowing it to uncover long as well as short opportunities across credit markets. The long / short buckets seek to enhance the fund’s ability to deliver returns that are uncorrelated market, while the tactical overlay may enable the team to limit volatility and manage drawdowns in a flexible manner. The strategy operates in a wide investment universe (Investment Grade and High Yield) which provides diversification and is generally devoid of any specific bias. The track record since launch has been encouraging, with the fund delivering positive returns and controlled volatility in highly turbulent markets.
A process that flexibly Implements the best ideas of the High Yield Team
Our approach is primarily bottom-up driven and relies on rigorous credit research with the aim to generate outperformance. We also consider top-down (sectoral and regional) allocation as secondary sources of returns, while a material portion of alpha is also generated through our tactical overlay strategies that involve credit market exposure / hedging and duration management.
A preliminary filtering of the investment universe is applied based on ESG (controversial activities) and liquidity exclusion criteria. A detailed assessment of the economic, sector and industry framework is carried out in order to identify and select the best opportunities in the market. The investment teams establish a macro-economic scenario, identify opportunities as well as macro risks, top-down preferences in terms of sector, region, and rating.
The bottom-up analysis of issuers and issues forms the cornerstone of bond selection and is the main source of added value. This allows our portfolio managers to identify new investment ideas, to follow the credit quality of issuers over time, to gauge the impact of new information, and to determine optimal entry points. The High Yield Team at Candriam boasts of significant industry experience and a sturdy track record that goes back to 1999. The team also relies on quantitative tools to constantly monitor credit market valuations across sectors, ratings, regions, and instruments in order to generate ideas and eventually implement positions.
Portfolio construction is a function of valuation, technical factors and market timing and is implemented by the key decision makers: Nicolas Jullien, Global Head of High Yield; Thomas Joret, Senior Fund Manager; Philippe Noyard, Global Head of Fixed Income. Nicolas Jullien, lead manager of the strategy, retains final decision-making authority. Finally, the positions are monitored in real time and strict sell discipline, based on convictions, is implemented.
A proven track record
The Candriam Bonds Credit Alpha fund was launched in February 2021 and its objective is to use discretionary management to generate an absolute performance superior to the €STR© (capitalized) index with an ex-ante volatility target of less than 10% under normal market conditions. Volatility could nevertheless be higher, especially under abnormal market conditions.
Net Performance[1] (as of 31/03/2023)
Source: Candriam. Inception date 04/02/2021. Benchmark: ESTR Capitalised index. As of 01/01/2022, the index used as a benchmark, EONIA Capi 7dhas been replaced by ESTR Capi. Past performance of a given financial instrument or index or an investment service or strategy, or simulations of past performance, or forecasts of future performance does not predict future returns.
Since its inception, the fund has delivered a performance of 6.8% (I-Share EUR ND) at end March 2023, outperforming the €STR© index, with a volatility that is well below 10%[2]. It is important to note that this performance has been achieved under highly stressed credit markets, with investment grade and high indices posting negative returns. This demonstrates the fund’s ability to deliver uncorrelated and positive returns in highly unfavorable market conditions and place the strategy as a viable absolute return strategy.
Because navigating the credit market is likely to be complex in the coming weeks or months, adopting an absolute performance strategy seems to be a smart solution for informed investors.
Risks
All our investment strategies are subject to risks including the risk of loss of capital.
The main risks associated with the Candriam Bonds Credit Alpha fund are the following: Risk of loss of capital, Interest rate risk, Credit Risk, Liquidity Risk, Derivative risk, Counterparty Risk, Arbitrage Risk, Sustainability Risk.
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Warning: Past performance of a given financial instrument or index or an investment service or strategy, or simulations of past performance, or forecasts of future performance does not predict future returns. Gross performances may be impacted by commissions, fees and other expenses. Performances expressed in a currency other than that of the investor's country of residence are subject to exchange rate fluctuations, with a negative or positive impact on gains. If the present document refers to a specific tax treatment, such information depends on the individual situation of each investor and may change.
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[1] Data as of 31/03/2023. I Share Class EUR. The fund is actively managed, and the investment process implies referring to a benchmark index Capitalized €STR©. Performances expressed in a currency other than that of the investor's country of residence are subject to exchange rate fluctuations, with a negative or positive impact on gains. If the present document refers to a specific tax treatment, such information depends on the individual situation of each investor and may change.
[2] Source: Candriam - Data as of 31/03/2023