Resilience versus equity

17 September 2018

Olivier Mulin

RAM (Lux) Tactical Funds - Convertibles Europe


In August, European stock markets declined by -2.6% (SXXE Index total return), with Emerging Markets, Italy and Donald Trump’s policy once again at the core of volatility.

Argentina and Turkey have been at the heart of the emerging markets sell-off. The weak fundamentals (twin deficits, high dollar-denominated debt, and inflation) sent the local currencies to record lows, with the Argentinian peso and Turkish lira decreasing respectively by 38% and 35% against dollar over the month. This emerging background, coupled with an increasing threat of a trade war between the US and several of its key partners, intensified fears of a global economic slowdown.

In Italy, the upcoming budget law and delay in structural reforms fueled the risk-off sentiment. In addition, Fitch and Moody’s are due to review the nation’s credit rating in the coming weeks. A one notch downgrade would leave Italy as Investment grade (at just one level above junk). As a consequence, spreads between Italian 10-year government bonds and German bunds increased by + 63 bps over the month, at 290 bps.
Against this backdrop, on an equity sector perspective, cyclicals and financials (Basic Resources, Auto and Banks) underperformed defensives. Furthermore,

Growth and Momentum stocks (MSCI Eu growth total return: + 0.5%) generated better return than the Value thematic (MSCI Eu Value total return : - 3.3%).
On the Forex front, the US dollar rose by +0.9% against euro, at 1.1596, benefiting from a flight to quality as geopolitical tensions mounted.
Regarding the credit market, high yield bonds underperformed the investment grade segment over the month. Indeed, high yield spreads over swaps widened by + 17 bps in average (EU0HHYTO Index).

Convertibles market

European convertible bonds, namely the ECI Europe Index, posted a performance of +0.6%. The asset class benefited from a monthly outperformance of underlying equities (ECI Europe bond Underlying index : -0.6% ), a decrease in EUR and USD long term rates (-5 and -11 bps for the EUR and USD 5y swap rate) and a positive forex effect (20% of the ECI Europe index is represented by USD denominated convertible bonds).
Regarding valuations, the European implied volatility remained stable at 28%, with an IV spread vs listed options around 7 pts.
In the universe, the real estate and health care equipment names outperformed following quarterly results which were above expectations : Leg Immo 0% 2021 +9% ;  GN Store Nord 0% 2022 +7.9% ; and Qiagen 0% 2019 +6%. On the contrary, the retail sector suffered from specific stories: Follie Follie 1% 2019  -24.3% due to an event of default ; and Rallye/Casino 5.2% 2022  -14% following rumors of accountancy problems. We were not exposed to these bonds.


In August, the I EUR class of RAM (Lux) Tactical Funds-Convertibles Europe saw a net underperformance of 113 bps vs the benchmark (Exane ECI Europe) and delivered an overall performance of -0.51% for the month. Nevertheless, relative to equity, the Fund provides resilience with a better performance than its theoretical equity sensitivity (empirical: 20% vs theoretical: 35%).
Relative to its benchmark, the Fund was negatively impacted by its stock picking in industrial and construction sectors (i.e. Siemens -7%, Implenia -21%, following lower than expected full year guidance), its underweight on momentum stocks with demanding valuations (Sika +5%, Qiagen +7%), and its exposure to basic materials (Arcelor : -5.7%). Furthermore, our lower rate sensitivity and our currency hedging strategy were also headwinds in such an environment over the month.
On the other hand, the rise of WPP (+7%), fueled by high expectations on the new CEO’ strategy, was a positive element to note.
Regarding trading activity, we benefited from weakness to reinforce our positions in Siemens 1.65% 2019.


Top Contributors of the Month 

RAM Convertibles EU: Positive Monthly Contributors

RAM Convertibles EU: NegativeMonthly Contributors

*Sources : RAM Active Investments