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Investment Vehicle Manager Market & Portfolio Commentary - 2020

30.06.2020

The recovery that started in April across financial markets continued in May on the expectation that the worst of the Covid-19 crisis is behind us. Economic activity is gradually picking up again and so far there are no signs that this will lead to a second wave of infections. The new EU recovery fund, proposed by President Macron and Chancellor Merkel, was also positively received by the market. Equities performed strongly across the board and the +6.8% move in the NASDAQ means the index is now positive on a Year to Date ("YTD") basis despite some of the worst macro indicators on record.

European Sub Investment Grade Highlights

Loan issuance in Europe picked up marginally during May and reached €3.52bn during the month bringing YTD issuance to €30.55bn. This is in line with the €30.70bn loan issuance we saw over the same period in 2019. However, it’s worth noting that about €25.35bn of the €30.55bn YTD issuance came in the first two months of the year with only €5.20bn in the next three months.a

The Credit Suisse Western European Leveraged Loan Index, hedged to Euro, was up 3.28% for the month which brings YTD returns to -5.29%. Cyclicals (4.03%) outperformed defensives (2.56%) again during the month and CCCs (4.43%) outperformed Bs (3.51%) and BBs (1.25%). At the end of May, the discount margin on the index, using a 3-year life, was 654bps which is down considerably from the 968bps at the end of March but still well above the 399bps at the end of January. The Credit Suisse Western European High Yield Index, hedged to Euro, was up 2.91% for the month bringing YTD returns to -7.92%.

As we saw clear progress on lifting restrictions and opening up of economies around the world, coupled with continued supportive action and rhetoric from central banks and governments, risk markets furthered their April rally. Across credit, there were significant inflows in Investment Grade ("IG") and High Yield ("HY") securities across the EU and US, along with the tentative restart to CLO creation. EU HY net inflows for May were €900m (€4.4bn net outflows YTD) and EU IG €4.4bn inflows (€3.6bn net inflows YTD).b Despite the positive technical, an important factor in supporting credit was the insight that market participants were collating in individual credits regarding liquidity, and Q1 performance data and expectations helping to subdue investors’ concerns and support strong recoveries in the month.

Within the performing portfolio, as discussed, there was a stable price appreciation of higher quality names in defensive sectors which were added to the portfolio during the period of volatility in March. The themes around portfolio management in this segment remain as before: (i) trimming positions at profit where the relative value became unattractive; (ii) rotating out of Covid-19 impacted sectors/geographies to include credits where there is CCC downgrade risk, and; (iii) maintaining exposure to defensive stable issuers in light of our concerns regarding the longer term strength of the market. In addition, as the new issue market opened for high-quality issuers, the portfolio did allocate to this as it's anticipated that it will remain resilient through the coming quarters given the attractive pricing and more creditor friendly documentation. As of May close, performing credit (including cash) was at 35.4% of the portfolio with a weighted average price of 96.4, trading at a YTM of 4.5%, delivering 3.9% cash yield to the portfolio.

Within credit opportunities, the portfolio remains very focused on exiting exposures which required more proactive engagement and management. As noted, individual earnings reports and guidance for March, April and May have tended to be better than the expectations of the management teams and investors as operating costs and cash flows adjustments have been more effectively supported by fiscal or government access to liquidity. On the small short exposure, as liquidity returned to the market through central bank support and therefore offering limited portfolio protection, these were partially reset at higher levels. Within the small structured finance portfolio, having actively traded this book through April, this portfolio recovered with the broader market as the underlying collateral value appreciated through the month and spreads tightened. As of May close, credit opportunities was at 64.6% of the portfolio, trading at a weighted average price of 80.9 and a YTM of 13.0%, whilst delivering a 7.0% cash yield to the portfolio.

On a total portfolio basis, as of May month end the weighted average market price was 85.1, trading at a YTM of 10.4%, and delivering 7.3% cash yield versus a weighted average price of 94.7, YTM of 6.6% and cash yield of 5.7% as of December 2019. Floating rate instruments comprised 87.8% of the portfolio. Senior Secured 84.1%. The portfolio had a cash position of 7.3% (including leverage) with leverage at 1.3x assets.

The portfolio performed in line with our expectations across the performing credit strategy which benefited from the positive risk sentiment, lifting quality issuers in the secondary market. The credit opportunities strategy has not recovered as quickly, not unsurprisingly since liquidity in the secondary market is thinner and the nature of the individual credit stories are anticipated to take longer to show fundamentals or catalysts to drive price appreciation and recovery.

Like April, May was a very active period of trading across both the performing credit and credit opportunities portfolios to position the strategy for the coming 12-18 months and we remain positive on the market opportunity and positioning of the strategy. Performing credit continues to trade at attractive levels versus historic valuations and credit opportunities is expected to provide attractive return opportunities tracked by the team across multiple industries and geographies as global economies open up and adjust in the quarters ahead.

Sources

a LCD, an offering of S&P Global Market Intelligence - June 2020
b Courtesy J.P. Morgan Chase & Co., Copyright 2020, European Credit Research Weekly Update – 05 June 2020

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