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New Capital Fund Lux - EUR Shield

Marketing Communication | Quarterly Commentary

Market Update

The European Central Bank (ECB) cut interest rates for the first time in almost five years (-25bps to 3.75%) but warned future reductions would depend on price pressures easing further. This has been considered as a milestone in the fight against inflation (the Bank said the move was a response to a more than 2.5% fall in eurozone inflation since its last rate increase in September 2023). Lagarde affirmed there was a “strong likelihood” the decision marked the beginning of “dialing back” rates from their all-time high and – at the same time – she reiterated the data dependency attitude. The ECB remained vague about future reductions in interest rates, “not pre-committing to a particular rate path” with future decisions to be data dependent. While inflation in the region has come down from its peaks, the central bank cautioned that it expected inflation to remain above its 2% target until the final quarter of 2025.

In May eurozone inflation rose for the first time in 2024 to 2.6%, core inflation accelerated from 2.7% to 2.9%. Until this month, it had been gliding gently down towards the ECB’s 2% target all year, allowing policymakers to clearly signal they expect to start cutting (as they did) the benchmark rate from its record high of 4%.

As pointed out by the PMIs, services activity in the eurozone continued to expand in Q2 and the pace of slowdown in manufacturing improved further. However, the flash PMIs in June saw a setback amid rising political uncertainty.

European elections took place at the beginning of June: strong gains for right-wing parties, but with the centrist coalition holding its ground. This suggests continuity for EU policies, with Von der Leyen likely being confirmed as Commission president for a second term, although the gravity of EU politics may shift to the right. The big surprise came from France, where President Macron announced that new parliamentary elections would be held on 30 June and 7 July. This could lead to a ‘cohabitation’ between Le Pen as PM and Macron as president. Yet, Macron will be hopeful that France’s electoral system, different to the EU elections, may benefit him. In Germany, the country will be facing difficult budget negotiations over the summer, something that may be complicated by the poor results of the coalition parties. In Belgium, the outcome for the far-right parties will complicate the formation of governments at both the regional and national levels.

General widening of spreads occurred especially on the government paper: President Macron's call for snap parliamentary elections came as a surprise to the market, as price action testified. 10y OAT/Bund spreads have widened 20bps +, testing levels last experienced in October 2023 amid a 10y BTP/Bund widening to 220bp.

On the fiscal front, as part of the European Commission Spring Package, Brussels proposed to open an Excessive Deficit Procedure (EDP) for seven EU countries with a deficit higher than 3% of GDP, including France and Italy.

In geopolitics, conflict in the Middle East continued and trade tensions escalated between the EU and China on the back of various trade investigations into Chinese imports by the EU. This ended up with the EU levying provisional tariffs of up to 38.1% on electric vehicles imported from China from 4 July.

Rates markets saw yield rises and then falls over Q2, largely driven by volatile inflation data and changing central bank expectations. The 10y OAT-Bund spread widened to 79bps in June amid political uncertainties fueled by President Macron’s decision to call early legislative elections – though this widening was largely attributable to falling Bund yields. 10y Bund and 10y Gilt yields largely mimicked 10y US Treasury movements over the quarter.

Global high yield (HY) and investment grade (IG) credit spread indices widened marginally for the first time in the last five quarters. The widening was more pronounced in HY credit compared to IG in both USD and EUR credit. Notably, EUR IG and HY credit spreads widened the most in June after the surprise call for snap elections in France. Otherwise, volatility was generally very low for most of the quarter.

Euro IG saw gross issuance of €165bn in 2Q24, the sixth heaviest quarter on record. However, almost all of this was refinancing, with only very limited net supply of €19bn.

Short EUR IG corporates delivered a positive performance during the quarter: 1-3y bucket delivered +0.86% (the Fund’s reference market, ICE BofA 1-3 Years Euro Corporate Index), 3-5y bucket posted +0.46%, while 5-7y bucket -0.05%, 7-10y -0.68% and 10+y -2.39%.

In terms of sectors only financials delivered positive performance (+0.44%) while both industrials (-0.04%) and utilities (-0.36%) set in negative territory on the quarter. Looking at sub-sectors banking has been the best performer (+0.37%), followed by energy (+0.18%). Among the worst ones we find consumer non-cyclicals (-0.34%) and utilities, telecoms and capital goods (-0.27%).

Fund Performance & Positioning

In Q2 the Fund delivered a positive absolute return of +0.6%, and +0.8% since the beginning of the year.

During the quarter, looking more in detail, we acknowledged that the slight underperformance in relative terms versus the benchmark was due to: 1) the overexposure to the longest maturities (- 13bps) - here the positive performance of the 3-5y bucket in June (+4pbs) was not sufficient to offset the first two months of the quarter; 2) the selection in the financial sector (and the absence of subordinated bonds as per our cautious approach) cost the Fund 11bps.

In terms of countries, at the end of the quarter we are exposed to 15 countries while the reference index is differentiated among 42 countries. Our major overweights are in the United States (+7.2%), Canada (+5.6%) and Spain (+4.3%). Major underweights are in the Netherlands (-5.2%) and France (-5%). We never had exposure to China, Hong Kong, the UAE and other minor countries which are present in the benchmark (i.e. Eastern EU countries).

On duration, the Fund maintained a neutral stance over the period (1.96 years vs 1.92 years of the reference market) underweighting 1-3y bucket (-1 year) fully compensated by overweighting 0-1y (+0.10y) and 3-5y (+0.95y). This positioning was built in the first quarter.

From a sector point of view, the quarter ends with an overweight to a long lasting and well-diversified group of senior financials (61% vs 49%) and consumer cyclicals (16% vs 9%) while we are slightly underweighting a few sectors such as industrials and consumer non-cyclicals by 5%, and energy and basic materials by 4% and 3% respectively.

On ratings, we maintained our overweight in the AA (+4.5%ca.) and A (10%ca.) buckets through the quarter, while we always have been underweighted on the BBB bucket in the range of 15%-16%. Overall, the portfolio enters the third quarter with an A- average rating (as the reference index), 3.86% yield and 1.96 years of duration.

We think we are starting to see a normalization of the yield curve, that, given the multiplicative effect of the duration, is going to positively impact the slightly longer part of the curve. In order to profit from this movement, we are repositioning the portfolio to some longer duration. This has temporarily increased the absolute risk which is now in line with the benchmark (1.20% vs 1.21%). We think the opportunity is worth the slightly higher risk.

At the end of the quarter, we are invested in 76 positions (vs 1299 of the reference index). We continue to find enough opportunities in the investment grade market with no need to consider high yield issues. Our defensive positioning allows us to avoid aggressive and volatile positioning such as low rated bonds (high yields) and/or very volatile ones (subordinated bonds). As a reference we have never been invested in Credit Suisse, China, Russia and real estate linked issuers.

In terms of activity, we joined the primary market (or switched positions) that provides a better diversification, increased yield and improved our ESG score. We focus on the 1-3y and 3-5y bucket.

The Fund has always had only euro denominated issuers, so there is no forex exposure. No derivatives have been used. In addition, it's worth noting the Fund is an Article 8 with 55.7% ESG score vs 55.2% of the reference index at the end of June. Green bonds at the end of the quarter stood at 25.5% vs 12% of the reference index.

New Capital Fund Lux - EUR Shield ICE BofAML 1-3 Year Euro Corporate Index Difference
1 Month +0.38% +0.48% -0.1%
3 Month +1.8% +2.02% -0.22%
6 Month +2.54% +2.88% -0.34%
YTD +2.15% +2.85% -0.7%
1Yr +5.02% +5.56% -0.54%
3Yr Annualized - - -
5Yr Annualized - - -
Since inception annualized +2.24% +2.86% -0.62%
Since inception 05.07.2022 +4.88% +6.26% -1.38%

Please note that the decision to invest in the promoted fund should take into account all the characteristics or objectives of the promoted fund as described in its prospectus. For more information on sustainability-related aspects please visit the ‘Article 8 Disclosures’ section on https://www.newcapital.com/responsible-investing.html Past performance is not a guide to the future. The value of your investments and the income from them may fall as well as rise as a result of market as well as currency fluctuations and you may not get back the full amount invested. Fund performance is net of fees and representative of the USD I Acc Share Class and shows a maximum of five previous calendar years and current year to date (computed on a NAV to NAV basis). Where share class inception begins prior to the five previous years the chart has been rebased to 100. Where the Fund has fewer than five full years of performance, returns are shown from the inception date. Source: EFG Asset Management, Bloomberg.  As at 31 Aug 2024.

Outlook

While the results of French legislative election may have implications for domestic policy, it will likely be less consequential for the euro, given the limited ability of the incoming parliament to implement material changes in foreign policy without input from the President.

The spillover effect on peripheral spreads has to be monitored following French elections developments. BTP spreads were rich coming into this surprise election announcement and concerns regarding a potential resignation from President Macron pushed spreads wider. The market positioning seems to be an unwind in a risk-off move rather than the pricing of eurozone break-up concerns, at least for the time being.

In France corporate bonds may continue to outperform OATs going forward, given the higher starting yield, corporates' globally diversified revenues, and not least because the supply technicals are more challenging in sovereign bonds than corporates, with both higher net supply and a more meaningful impact of quantitative tightening relative to the size of the market. The market continues to build risk premium into the French election as political uncertainty increases and the market asks questions on potential fiscal instability from both right and left wing policies. OAT-Bund spreads have widened ~30bps since the announcement. French corporate names will remain volatile as well. Having said this, although market focus remains on elections in France, we should keep in mind that European credit is a very well diversified asset class, with French issuers only accounting for 20-25% of the key benchmarks. Importantly, nearly three-quarters of these issuers' revenues are actually generated abroad, which should limit the spillover from election risks into corporate credit fundamentals.

Since inception (July 2022) the Fund has underweighted France by 5-7% versus the reference benchmark (c20%). The quantitative model embedded within the investment process continually looks for absolute diversification, instead of considering deviation from the benchmark, looking for alternatives to the French issuers. From a qualitative aspect, France has never been one of the preferred countries in the portfolio primarily due to high public and private debt. Indeed, in a recent report S&P explained why they downgraded French debt to AA-. The key risk for France is not government debt (public debt/GDP is 123%), but private-sector debt, especially corporate debt. Total French private debt/GDP averaged 216.50% from 1995 until 2023, reaching an all-time high of 296.80% in 2020; whereas in Italy the average remains at 157% (source: OECD), where significant private-sector deleveraging occurred in the last few years.

Given the instability expected to continue ahead of the elections, the Fund will maintain its cautious and diversified approach, whilst continuing to avoid areas of higher structural risks. Currently, we see France as adding volatility both on sovereign and corporate markets, and importantly, not (yet) compensated by enough yield.

As expected, activity on the primary market has continued to be strong and the investors are still very receptive to new issues, with the investment grade space (our reference market) leading the way. That’s the reason we’ll continue to actively join the primary market to find new opportunities, while being always very selective (i.e. no real estate).

Looking at the portfolio we will continue to follow our approach that aims to maximize diversification through a strong and repeatable investment process.
Our proprietary risk tool is picking up a series of small idiosyncratic risks in the investment universe that we do not want to run after, while we make sure we are better diversified on the main risk factors. In fact, we continue to avoid subordinated bonds, low liquidity issuers/bonds and countries such as China.

Looking at risk metrics we understand those elements seem to be an important missing factor in our portfolio diversification, but we like not to be exposed to those factors. We are focused on delivering a cautious approach, being aware that over the short term we can miss some temporary opportunities. At the same time, we continuously screen our universe for the positions with the highest diversification potential to find new opportunities while always looking at the new issues on the market (and this will be more evident in these months which are at the beginning of the year).

In our view, the portfolio is well positioned to capture the upside from stabilization in either a global negative or positive scenario having a well-balanced exposure to credit, while being on a high potential position on the yield curve.

We believe the Fund, which focuses on the short-term high-quality investment grade universe, represents a good instrument to be invested in, for a number of reasons: our totally embedded risk framework process (which aims to preserve capital), current yields levels (not seen since 2008), current yield shape and European Central Bank monetary policy ahead.

Finally, it’s worth remembering that the Fund can offer a solution for de-risking asset allocation in every portfolio, by providing a repeatable and cautious approach to investing in the short term investment grade universe.

Disclaimer

MARKETING COMMUNICATION

This document has been produced by EFG Asset Management (Switzerland) SA is authorised and regulated by the Swiss Financial Market Authority. Registered address: EFG Asset Management (Switzerland) SA , Quai du Seujet 24, 1201 Geneva, Switzerland. Telephone +41 22 918 71 71. 

All sources: EFG Asset Management (UK) Limited ("EFGAM"), Factset, Bloomberg, Morningstar as at end of the month.  Any other sources as applicable.  

This document has been prepared solely for information purposes. The information contained herein constitutes a marketing communication and should not be construed as financial research or analysis, an offer, a public offer, an investment advice, a recommendation or solicitation to buy, sell or subscribe to financial instruments and/or to the provision of a financial service. It is not intended to be a final representation of the terms and conditions of any investment, security, other financial instrument or other product or service. The content of this document is intended only for persons who understand and are capable of assuming all risks involved. Further, this document is not intended to provide any financial, legal, accounting or tax advice and should not be relied upon in this regard. The information in this document does not take into account the specific investment objectives, financial situation or particular needs of the recipient. You should seek your own professional advice (including tax advice) suitable to your particular circumstances prior to making any investment or if you are in doubt as to the information in this document. 

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