MARKET COMMENTARY
When we predicted at the end of 2024 that 2025 might hold some surprises, we certainly did not anticipate so many, so quickly. Geopolitical risk (check), Transactional Trump (check), higher volatility or at least regular spikes (check), Europe closing the gap with the US (check) and a broadening of performance away from the Magnificent Seven into other parts of the market (check). The good news for convertible bond investors is that the asset class did what it is designed to do – in February, global balanced convertibles outperformed the MSCI World and high-yield credit, performed in line with investment-grade and participated with 75% of the performance of the underlying equities. The Fund has captured two-thirds of the performance of the underlying equities year-to-date, outperforming its benchmark, equities and credit.
European governments were left scrambling to boost their defence budgets after President Trump withdrew US support for Ukraine and, in no uncertain terms, declared that America could no longer be counted on to finance or arm conflicts on foreign soil. A rather chastened President Zelensky returned to Kyiv and issued a hurried apology in the hope that US-led negotiations with Moscow might resume and subsequently result in a mutually palatable solution. MAGA (Make America Great Again) has turned into MEGA (Make Europe Great Again), pushing the DAX more than 12% ahead of the S&P500 year-to-date. The outcome of the German election was an unsurprising win for the right-wing CDU/CSU, with Friederich Merz the frontrunner to become Chancellor if he can negotiate a working coalition. More of a surprise was the proposed fiscal package that meaningfully changes the medium-term economic outlook for Europe’s largest economy. Measures include national fiscal reform to exclude the higher defence spending from the debt-brake limit, reform of the debt brake at the state level to provide more flexibility at a local level, and a EUR 500 billion Special Purpose Vehicle to be enshrined in the constitution for infrastructure expenditure over the next decade (11.6% of 2024 GDP). The measures were hailed as a paradigm shift and a much-needed boost for the morose German economy, which has only barely avoided recession in recent quarters. Defence and engineering group Rheinmetall, one of the main beneficiaries of the reforms, has emerged as the unlikely “NVIDIA of 2025”, with its share price almost doubling since the start of the year. The announcement of the fiscal package pushed 10-year Bund yields up 30 bps, the biggest move in 35 years almost to the day. The previous move was ahead of German reunification in 1990. Investors are pouring money into European equities at a rate not seen since August 2015, with almost EUR 12 billion in inflows in the four weeks through 5 March.
The other big winners of 2025 have been the main Asian Technology names (e.g. Alibaba and Xiaomi), which have rallied massively on AI optimism, despite the threat of a trade war with the US. Alibaba stock has risen 60% year-to-date and, as one of the biggest deals in our universe, the name has generated generous returns for convertible investors. The Chinese authorities are firmly back in the driving seat, and we expect that further stimulus measures will be announced at crucial policy meetings in early March.
For every winner, there has to be a loser, and this dubious accolade has fallen on the Magnificent Seven and the NASDAQ, which have been feeling somewhat unloved in recent weeks. There was a nasty sell-off in US stocks in the second half of the month after preliminary PMI (Purchasing Managers’ Index) readings showed that US business growth is close to grinding to a halt. Services contracted for the first time in more than two years, housing data was negative, and then came Michigan Consumer Sentiment, which was overwhelmingly negative, compounded by the Atlanta Federal Reserve estimating that real GDP is likely to contract sharply in Q1 2025. Despite all of the negative news flow, the US consumer remains employed, real incomes continue to rise, inflation is at/close to target and the Federal Reserve is likely to look through the recent tariff-driven inflation spike when considering the future path of US interest rates.
NEW ISSUANCE
The primary market got off to a slow start in January, but the pace improved in February after the US Q4 earnings blackout was lifted. Globally, USD 6.3 billion was priced last month, almost double January’s total, largely dominated by the US (USD 5.3 billion). Despite some investor fatigue, repeat crypto issuer Microstrategy raised a further USD 2 billion via a 0% coupon deal due in 2030. There were also deals from Unity Software, BridgeBio Pharma and the Cheesecake Factory, which was gobbled up by investors. In Asia, there was a deal by repeat issuer IQIYI Inc, and a synthetic issue for Vinci SA in Europe.
PERFORMANCE
The Fund rose 1.2% in February, marginally behind the benchmark index for a year-to-date total of 3.6%, in line with the FTSE Composite benchmark. The MSCI World equity index fell 1.1%, global high-yield hedged in EUR gained 0.7%, high-yield added 1.4%, the VIX volatility gauge ticked up from 16% to 21% and credit spreads closed the month unchanged. The main performance drivers were all positive in February (equity, credit, income, rates, volatility). By region, in absolute terms, Asia rose 1.4% and Europe gained 0.5%, while the US lost 0.7% and Japan fell 0.1%. The European exposure contributed to relative gains (+27 bps) but other regions detracted (US -42 bps, Asia -6 bps and Japan -4 bps).
Most sectors were positive, led higher by Consumer Cyclicals +1.0% (especially in Asia), Utilities +0.3% (mainly in the US), and Communications +0.2%. Technology (-0.5%) and Financials (-0.2%) were negative.
The returns in Consumer Cyclicals were dominated by a 91 bps contribution from the position in Alibaba. European food delivery platforms Delivery Hero and Just East added a further 17 bps and the Asian electric-vehicle manufacturers Li Auto and NIO Inc contributed 13 bps. Detractors included Norwegian Cruise Lines (-8 bps), US household goods e-retailer Wayfair (-6 bps), whose shares fell 18% in February after mixed results, and US electric-vehicle manufacturer Rivian (-4 bps), which produced a good set of quarterly numbers that were overshadowed by concerns over ongoing demand. The US Utilities did well across the board: Southern Energy +13 bps, CMS +11 bps, Duke Energy +5 bps, PG&E +1 bp. The gains in Communications were spread across a number of names, with the biggest contribution from Asian media and gaming giant Tencent, which added 7 bps after an almost 20% rise in the share price in February. Audio streaming solutions provider Spotify also contributed. The company has had a strong start to the year, while Q4 revenue growth convinced investors that it is likely to continue to generate sustainable returns in 2025. Its strategy of price differentiation between premium and free subscribers has proved to be effective. Cellnex, Europe’s largest independent operator of wireless telecommunications infrastructure, added 3 bps after solid Q4 2024 results and the announcement that it will start a EUR 800 million share buy-back once the Irish business has been sold.
In Technology, hardware and equipment names did well (Xiaomi +20 bps, Lenovo +13 bps, Seagate +2 bps), as did the infrastructure software names (Nutanix, Applied Digital, Snowflake). The position in Akamai detracted by 21 bps. Top-line growth continues to expand, but some legacy products are decelerating and other new business segments are taking time to reach their full potential. Lumentum lost 12 bps after a quarterly margin miss, although we expect the company to benefit from increasing hyperscaler capex. The weakness in Financials was due to a 19 bps loss for cryptocurrency platform Coinbase. The price of Bitcoin fell 17.5% in February after several weeks of substantial gains following the US presidential election.
In relative terms, Consumer Cyclicals contributed 14 bps, with 17 bps added by the food delivery platforms Delivery Hero and Just Eat (off-benchmark) and a further 13 bps from the overweight in EV-makers Li Auto and NIO Inc. In Industrials, the off-benchmark defence exposure in Rheinmetall and Rolls Royce added 15 bps and the overweight in Nordex contributed a further 4 bps. However, the positions in Fluence and Fluor detracted by 22 bps. Fluence stock sold-off sharply after a sizeable Q4 revenue miss. The underweights (for ESG reasons) in some of the US utilities (WEC, Evergy, PPL, UGI and Centrepoint) detracted.
OUTLOOK
Convertible bonds have had a strong start to the year. Having been penalised for its lack of Magnificent Seven in recent years, the universe is now outperforming as gains have spread more broadly into other sectors and themes. Asian cyclicals have had a particularly strong start, and having been somewhat overshadowed by America First in late 2024, Europe is also contributing to headline performance. Convexity has returned to the asset class, issuance is buoyant and many of the quality growth themes in convertibles are aligned with government policy and technological innovation. We are constructive on the potential for the asset class to generate returns in 2025.
