May was a difficult month for European credit

Published on 30 June 2021

May was a difficult month for some investment firms as spreads in hybrid corporate debt increased, which impacted performance, but opportunities were to be found in subordinated debt markets. The big risk in European credit is duration, the sensitivity to interest rate changes, and this risk is dependent on the US Federal Reserve’s activity, and US Treasuries and a question mark over French debt.

As Eric Vanraes believes investment managers need to consider handling the challenge of low yields and liquidity via hybrid-corporate bonds, subordinated debt and long-dated IG bonds, with duration hedged via a short position in the futures market.

Dan Barnes: Welcome to Trader TV – your insight into trading for professional investors. I’m Dan Barnes. Joining me today is Eric Vanraes, portfolio manager of the Strategic Bond Opportunities Fund, and Head of Fixed Income investment at Banque Eric Sturdza.

Eric, welcome back to the show.

Eric Vanraes: Thank you, Dan.

Dan Barnes: In credit in the very first quarter, we saw very high volumes in both primary and secondary markets. What investment opportunities did that create? And going into May where we’ve seen some drop off in volumes, how would you characterize the market?

Eric Vanraes: The volumes were high, but the investment opportunities were not so good. First and foremost, it was difficult to have a good allocation because I suppose that central banks were huge buyers of new issues and the new issues were not really interesting in terms of spreads, because spreads are too tight. High-Quality bonds are not interesting and we were very excited at the beginning of the year because we wanted to increase our investments in hybrid-corporate bonds, excluding financials and unfortunately the primary market was too low for us. We were a bit disappointed. Q2 and May is better. Q2 will bring opportunities, hopefully.

Dan Barnes: That’s great. And then specifically in May, how are credit markets performing?

Eric Vanraes: In May it was difficult. Our performance was dependent on portfolios between flat and slightly negative because hybrid-corporate spreads increase. So with wider spreads, we did not perform. But it was an investment opportunity to increase the weight of subordinated debt in our portfolios. But May was not a fantastic month, as usual, I would say.

Dan Barnes: And then where do you see risks and opportunities then in European credits in this quarter?

Eric Vanraes: Risk is duration because nobody knows the route could go to zero depending on the behavior of 10-year Treasuries, depending on the behavior of the Fed, because the ECB is very clear and the ECB will still be our friend, so no worries for a selloff in bulls or in very short spread, such as Italy or Spain. So the big question mark being France.

In credits, I think that there is one opportunity. It’s subordinated debt issued by industrial hybrid-corporate debt. It’s already the double of convertible bonds. It’s increasing every day. And it is very, very interesting because you have the mix of high spreads, but high quality, because instead of buying the debt of a low quality company, you buy into subordinated debt of a very high quality company.

Dan Barnes: What do you think portfolio managers and buy-side traders need to be cognizant of in credit today in order to deliver best execution and best returns for investors?

Eric Vanraes: Best returns, it’s difficult in this environment, so my strategy is always the same. In 2021, subordinated debt, hybrid-corporates and also long-dated investment grade bonds. But due to their high duration, we have to slightly hedge this duration through a short position in the futures market with bulls and US Treasuries.

Dan Barnes: That’s great. Eric, thank you so much.

Eric Vanraes: Thank you, Dan.

Dan Barnes: I’d like to thank Eric for his insights today and of course, you for watching. To catch up on our other shows or to subscribe to our newsletter, go to TRADERTV.NET.