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Market & Portfolio Commentary - September 2022
September started on a soft tone after Fed Chairman Powell's speech in Jackson Hole at the end of August, where he re-affirmed his hawkish stance. The negative sentiment continued throughout the month as central banks globally hiked rates aggressively and forward-looking growth indicators pointed towards a material slowdown ahead. Inflation readings continue to be high, but we have seen material weakness in commodity prices such as oil. Even European gas prices are down around 50% from the August highs (source: Bloomberg), which, in combination with government price caps, should take some pressure off inflation going forward. Turbulence then picked up towards month end as the new UK government announced a new fiscal package that put considerable pressure on GBP and gilts.
Sub Investment Grade Highlights
New issuance in both the European leveraged loan market and high yield market continues to be at low levels given the overall uncertain macro outlook. Transactions are getting done however, but at materially wider levels than last year. Total September loan issuance amounted to €6.6bn (Year to Date (“YTD”) €44.2bn) while HY issuance continues to lag at €1bn for the month (YTD €17.5bn).
The Credit Suisse Western European Leveraged Loan Index return, hedged to Euro, was at -3.4% for the month. Defensives were -3.1% and cyclicals -3.7% in September. CCCs in September were down -7.6%, single Bs -3.7% and BBs -2.3%. As at the end of September, the 3-year discount margin on the index was 728bps. The Credit Suisse Western European High Yield Index, hedged to Euro, was down -4.2% (YTD -15.8%).
The European loan market initially held up reasonably well in the first few weeks of September but then we saw some capitulation during the last few days of the month. In particular, we saw considerable pressure on the CLO marks in the portfolio. On the back of the UK’s new fiscal policy and the consequent volatility in the gilts market, LDI pension schemes came under pressure and became forced sellers to cover margin calls. In particular, we saw considerable selling of CLO tranches, mainly some of the higher rated tranches. Due to the large supply, there was a material re-pricing wider of these tranches. Despite considerably lower trading volumes in the BB and B tranches, these re-priced wider on the back of the investment grade tranches repricing.
Trading activity picked up materially in September, after a seasonally slow August. We continued to add slowly to our CLO exposure by averaging into the market in this weakness. Furthermore, we participated in the DIP financing of a leisure chain, which came at SOFR+10%, with a 98 OID. We also rotated some lower conviction names into names that should perform better in the current macroeconomic climate, and at the same time reduced some second lien positions and unsecured positions to move up in the capital structure given the macro uncertainty ahead of us.
Across the entire portfolio, as of September month end, the weighted average market price was 84.2, trading at a YTM of 15.1% (€ hedged) / 17.5% (GBP hedged), and delivering a 9.2% (€ hedged) / 11.6% (GBP hedged) running cash yield. This compares to a weighted average price of 96.5 and YTM 8.3% and 7.9% as of December 2021. The increase in yield is due to a) increase in base rates both in EUR and GBP, b) the lower weighted average cash price on the portfolio due to market weakness and c) the attractive new issue spreads we see both in the primary loan and CLO markets. Floating rate instruments comprised 82.8% of the portfolio while 73.0% was invested in senior secured assets. The portfolio had a cash position of 6.2% (including leverage) at the end of the month. Market consensus is for further increases in base rates both in EUR and GBP, which should lead to a higher yield profile on the portfolio.