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Market & Portfolio Commentary - June 2022
June was yet another risk-off month as investors are weighing up the impact of inflation, the possibility of a hard landing and the ramifications of the Ukrainian war on global growth. The main worry from investors is that the cumulative impact of all these factors will lead to a recession. With US mortgage rates reaching a post-2008 high, disruption in gas supplies to Germany and on/off lockdowns in China, the near-term visibility on the economy is fairly limited. Most asset classes finish the first half of 2022 materially down, including equities, credit and sovereign bonds. The only major asset classes that ended the first half in positive territory were oil and some other commodities.
Sub investment grade highlights
New issuance in both the European leveraged loan market and high yield market continues to be at very low levels given the overall uncertain macro outlook. In June, we saw €2.7bn loan issuance and €1.5bn high yield issuance. This brings the year-to-date ("YTD") total to €28.1bn for loans and €15.2bn for High Yield. These are multi-year low numbers as issuers who don’t have to issue financing are waiting for better market conditions.
The Credit Suisse Western European Leveraged Loan Index return, hedged to Euro, was at -3.07% for the month. CCCs in June were down –4.4%, single Bs -3.62% and BBs -1.22%. As at the end of June, the 3-year discount margin on the index was 725bps a 151bps widening since the end of May 2022.
The Credit Suisse Western European High Yield Index, hedged to Euro, was down -6.37% the sixth consecutive negative return month bringing YTD return to -14.9%.
We are at a point in the credit cycle where rising default rates feel more than priced in and the sell-off we have seen in the markets in June is likely more technical than fundamental. Banks continue to de-risk their balance sheets and actively sell loans in both the primary and secondary market, while investors don’t have sufficient cash balances to absorb this supply.
As a result of broader market volatility, the pace of new issuance remains slow, but the overhang of underwritten bridge loans remains fairly high. A challenged structured products primary market led to weakening loan prices throughout the month as investors are raising cash too. In response, our focus this month in the performing book was protecting the portfolio and managing risk accordingly. During the month, we reduced three positions, capitalizing on liquidity while rightsizing our risk as secondary prices declined. We also exited two positions during the month, one of which was the result of heightened credit risk as capital markets weakness may make a refinancing of the company’s short-dated capital structure more difficult. While we net reduced risk during the month, we maintain a keen eye on the drivers of demand for loan products – including a rebound in new CLO issuance – as we believe that performing loans offer attractive convexity upon a re-emergence of demand. As of June close, performing credit (including cash) was 46.8% of the portfolio, trading at a weighted average price of 88.8 and a YTM of 7.8%, whilst delivering a 5.3% cash yield to the portfolio.
The credit opportunities book remains a significant focus as the macroeconomic backdrop stands challenged. We managed existing risk during the month while monitoring the evolving opportunity set across the market. Despite a slight increase in the size of the opportunity set, the quality of the pool remains challenged, and as such, we did not add any new names to the credit opportunities book during the month. In June, we reduced one existing position that had not traded in several months, capitalizing on liquidity while rightsizing our exposure. We consistently screen new opportunities while maintaining keen focus on names owned across the CVC Credit platform that have faced operational pressure, and we are prepared to move quickly when attractive prospects arise. Within the structured products sleeve, we participated in the BB and B-rated paper of one new CLO issuance during the month. We also topped up on our exposure across a BB-rated position at a significant discount, further improving its convexity profile. We generally remain opportunistic in our approach to structured products deployment, and our selective style has further aided risk-adjusted returns. As of June close, credit opportunities was 53.2% of the portfolio, trading at a weighted average price of 81.9 and a YTM of 14.3%, whilst delivering an 9.1% cash yield to the portfolio.
Across the entire portfolio, as of June month end, the weighted average market price was 85.0, trading at a YTM of 13.9% (€ hedged) / 15.6% (£ hedged), and delivering 8.7% (€ hedged) / 10.4% (£ hedged) cash yield (on a levered basis) versus a weighted average price of 96.5, YTM of 8.3% and cash yield of 7.9% as of December 2021. Floating rate instruments comprised 81.1% of the portfolio. Senior Secured 71.2%. The portfolio had a cash position of 3.3% (including leverage) with leverage at 1.4x assets.
As summer months begin, macroeconomic and geopolitical uncertainty – met by central bank action globally – have contributed to continued market volatility. Against this backdrop, the performing book remains well-positioned for current income, and the credit opportunities book continues to offer attractive convexity. We will remain diligent in our investment approach while managing risk thoughtfully heading into the summer months.