Commentaries

Volatility’s Back

14 November 2018

Olivier Mulin

RAM (Lux) Tactical Funds - Convertibles Europe

 

In October, the European stock market declined by -6.60% (SXXE Index total return) suffering from a global risk aversion movement. Investors were unnerved by a range of issues; worries about global growth, disappointing earnings reports and noteworthy political events (Italy, Brazil etc.).

Regarding the global economy, while the U.S. remains robust (US GDP at 3.5% annualized rate in Q3), China and the Eurozone are losing momentum. China’s growth slowed to 6.5% in Q3, the weakest y/y growth since Q1 2009; and the Eurozone leading indicators gradually weakened (the composite PMI index reached its lowest level since September 2016).

As the Q3 earnings season is concerned, 50% of the Eurostoxx companies have reported, delivering +7% eps growth y/y, but +3% ex energy (source JPM), weaker than the previous quarter. In addition, many cyclicals companies released lower-than-expected Q4 margin and eps guidance mainly due to the U.S. tariff war, emerging economy’s softness and oil price inflation.

From a political perspective, budget discussions between Italy and the European commission remained tense. The Italian government has until November 13 to submit a revised draft budget plan. On a positive side, S&P left its credit rating unchanged at BBB and did not follow Moody’s agency move.

Against this backdrop, within the market, defensive sectors (Telecoms, Utilities, Food & Beverage) outperformed cyclicals, which have endured their worst month of performance since the collapse of Lehman Brothers (source Exane). In addition, Value stocks reduced their discount against Growth and Momentum styles (MSCI Europe Value TR - 4.1% vs MSCI Europe Growth TR - 6.4%). On the European sovereign bond market, the 10 year Bund returned to the 0.40% zone (-6 bps) and the peripherals 10 year premium (vs bund) widened: Italy +14bps, Spain +7 bps and Portugal +3 bps. Regarding the credit market, high yield bonds underperformed the investment grade segment over the month. Indeed, high yield spreads over swaps widened by + 39 bps in average (EU0HHYTO Index).

Convertibles market

European convertible bonds, namely the ECI Europe Index, posted a negative performance of -1.85%. The asset class suffered from the decrease of underlying equities (ECI Europe bond Underlying index: -6.99%) but performed better than its theoretical equity sensitivity (33%). It benefited from a positive forex effect (The U.S. dollar gained +2.6% against the euro over the month and 20% of the index is represented by USD denominated bonds), and a rise in valuation (+1.4 implied volatility points -source Exane).

In the universe, the real estate and retail names outperformed: Intu Properties 2.875% 2022 +10% on a takeover bid from a consortium; Industrivarden / ICA Gruppen 0% 2019 +8% following q3 results above expectations. On the contrary, the technology (Ubisoft: - 12%, AMS: - 10%), healthcare (Fresenius Medical: -12%) and luxury (LVMH: - 11%) sectors suffered due to disappointing results and /or Q4 outlook.

The only primary deals on the month were the JPM into Dufry 2021 tender and concurrent $205 M. new issue. We tendered the old bond and bought the new one to benefit from a more balanced profile with the same maturity.

Fund

In October, the PI EUR Class of RAM (Lux) Tactical Funds - Convertibles Europe saw a net underperformance of 22 bps vs the Benchmark (Exane ECI Europe) and delivered an overall performance of -2.06%* for the month.

Relative to its benchmark, the Fund’s underexposure to growth stocks (LVMH, AMS, Ubisoft) was an edge over the month. However, this positive effect was offset by the stock picking in Industrials (Siemens), Basic materials (Aperam: negative outlook due to excess supply from China which drove pressure on margins) and Media (Wpp: growth warning for Q3). Our currency hedge strategy also proved to be a headwind in such an environment.

Regarding trading activity, convertible bonds with unattractive profiles (high premium, high duration, low yield to maturity) were sold or reduced: Telecom Italia 1.125% 2022, Fresenius 0% 2024 and AMS 0% 2022.

 

Top Contributors of the Month 

RAM Convertibles EU: Positive Monthly Contributors

RAM Convertibles EU: NegativeMonthly Contributors

*Sources : RAM Active Investments