09 Février 2014

With a poor performance of credit indexes in the first month of 2014, investors are left wondering whether their long credit positions are overstretched. On the one hand, in high yield (HY), many European issuers start to benefit from a better economic environment and the strong primary market to improve their credit metrics and refinance their capital structure with better terms and conditions. And most European banks continue to be run in the interest of their creditors – with improving solvency, leverage and liquidity ratios – and their need to issue Basel III-compliant hybrid capital instruments provide attractive investment opportunities.

On the other hand, negative EM headlines combined with generally overweight positions led many investors to stay put while the relative value between certain borrowers changed significantly.

In a month when the iTraxx Xover index widened ca. 30 bps, names perceived as EM-exposed such as Portugal-based telecom operator Portugal Telecom, France-based telecom equipment manufacturer Alcatel-Lucent or France-based building material group Lafarge widened between 45 and 90 bps, while more European-domestic names such as Denmark-based service company ISS, UK-based retailed New Look and Italy-based conglomerate CIR ranged between flat and -10 bps. In IG, the same logic applied, sometimes with the addition of company-specific risks. Specifically, while the iTraxx Main index widened by 11 bps, France-based capital goods group Alstom, Spain-based telecom operator Telefonica and UK-based food retailer Safeway widened by 45 to 55 bps – courtesy of either EM risks, or idiosyncratic concerns around their rating and leverage outlooks, or both. In the meantime, credit spreads of companies with significant EM exposure but an improving credit outlook such as France-based media and telecom group Vivendi, Germany-based industrial gases manufacturer Linde or Germany-based consumer goods group Henkel tightened between 3 and 5 bps.

Dispersion in price action was also visible in the hybrid capital space. Additional Tier 1 bonds sold off by about 0.5 to 1.0 point during the month with the BBVA instrument falling by ca. 3.0 points while Société Générale rallied by ca. 1.0 point over the same period. The same pattern of dispersion occurred in financial CDS. The iTraxx Subordinated Financial index widened by ca. 20 bps, driven by the clear underperformance of bank institutions with a strong presence in EM such as Italy-based Unicredit (+38 bps), Spain-based Santander (+34 bps) or UK-based HSBC and Standard Chartered (+28 and 24 bps, respectively). In the meantime, more domestically-focused banking groups such as UK-based Lloyds, France-based BNP Paribas and Switzerland-based UBS showed better resilience and widened by 9 to 12 bps only.

We believe that such changes in the price action pattern of European credit markets may become more sustainable as EM woes persist and EU economies stabilize further. In our view, this should bring new interesting trading opportunities, as neither market levels nor investor positioning currently reflect this new hierarchy of risks where EM concerns now overcome peripheral concerns. The Fund’s current positioning and our research pipeline of new long and short situations is consistent with this market outlook, while reckoning that the current bout of relatively high market volatility pleads for caution.


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