MARKET REVIEW
The ECB embarked upon its quantitative easing programme in March, which duly supported government bonds and Bunds in particular. Corporates, on the other hand, underperformed, reflecting a “buy the rumour, sell the fact” response to QE after the strong returns in February. Corporate bonds also responded negatively to the strong supply in March. The buoyant supply was prompted in large part by the desire of non-European companies to access cheap funding given low rates and a weak euro. M&A featured strongly in March, with activity in the Telecommunication Services (Hutchison buying O2) and Food, Beverage & Tobacco sectors (Kraft merging with Heinz). The positive impact of this was more evident in returns for equities than for corporates. Greece remains a sideline issue for now, but the risk of a more dysfunctional outcome to the debt renegotiations remains high.PERFORMANCE COMMENT
The Fund’s total return was negative in the month. Despite the strong performance by government bonds and Bunds in particular,corporates recorded negative excess returns. Lower-rated credits underperformed higher-rated credits and mid-maturity bonds also underperformed. BBB bonds marginally outperformed BB bonds. In high yield, BB bonds underperformed single B credits. Tobacco and Telecommunication Services were the weaker sectors during the month in IG, with Banks doing better. Our overweight in financials versus non-financials added to returns as did our allocation to corporate hybrids.PORTFOLIO ACTIVITY
Strong supply in March led to weakness in primary market performance, particularly in IG credit. We avoided a number of new issues for this reason, but remained overweight corporates as we considered the weakness temporary. In Financials, we continue to prefer AT1 and Lower Tier 2 securities to senior bonds. We bought the new Deutsche Bank Tier 2 and prefer longer-dated and higher yielding bonds in this sector. In Industrials, we added select new BB names such as Campofrio and Merlin. We also added the new Bayer hybrid. Headlines on Lafarge and Holcim caused some softness in the spread differential between these two names. However, we continue to expect spreads to converge so we are staying with this rising star/fallen angel story. We reduced some of our overall overweight on corporates going into Q2 as we think headlines on Greece may provide better buying opportunities.
OUTLOOK
European fixed income remains firmly underpinned by the central bank bond purchase programme and regulatory requirements imposed on insurance companies and pension funds. But the likelihood of positive returns is lessening as bond yields move ever lower. The opportunities for outperformance are diminishing and with a more sustainable solution in Greece yet to materialise, we are cautious about chasing spreads. We still like corporate hybrids and aspects of bank capital, but idiosyncratic opportunities are harder to come by. Without a catalyst for a material sell-off though, we stay overweight. The trajectory for interest rates, particularly US rates, will be key to determining how far we move away from our current positioning. Markets are now pushing back on rate hike expectations for 2015 and European QE is acting as a further drag. Thus, the search for yield seems likely to persist for longer.
