Fixed Income Market overview
January rang in the new year with some uptick in macro volatility, as start of year flows and positioning coincided with the return of Donald Trump to the White House. That said, fixed income ultimately posted strong returns for the month, led by high yield spread compression particularly in the US, while Euro duration was the laggard. From a sectoral perspective, the main exception to the spread rally was in Euro capital goods and basic industry, likely stemming from tariff concerns. Early moves in markets to start the year largely followed the year end sentiment, with rates, particularly term premia, moving higher as concerns of fiscal profligacy lingered and uncertainty around the new Trump administration's international policy came to the forefront. The focus leading into Trump's Jan 20th inauguration focused on the prospect of sweeping trade tariffs, as markets wrestled to price the growth and inflationary impacts of such a move.However, rates reversed their global rise mid-month as rumours appeared to point towards less appetite than feared towards imminent tariffs from Trump's team. News flow for the rest of the month was erratic around this front, but fixed income markets ultimately looked through the noise and pricing as if they're expected to be specifically targeted or used more from a negotiating perspective, rather than a more damaging blanket implementation as alluded to in the build up to inauguration.Macro data itself continued its trend of gently declining inflation as lagged components of CPI normalize, whilst growth and labour markets continue robustly in the US but less so in the Eurozone. The continuation of this trend allowed for markets to find some footing after the aggressive rate sell off to start the year and was further supported by central bank meetings in line with expectations. The Fed paused the cutting cycle, as flagged at December's meeting, citing the need for more data on the inflation outlook, whilst the ECB cut again in the face of a drab growth picture.An outlier in the picture, and a trend that could have growing implications this year, was another 25bp hike from the Bank of Japan following a sharp pick up in headline CPI for December. This was the first move since their hike in the summer triggered a market rout as carry trades unwound. While market reaction was contained this time, with less than 35bps of hikes priced in for the year, further upside expectations for Japanese monetary policy is a trend to watch and could threaten another carry unwind if repricing happens suddenly. Another noteworthy development in the month came in the emergence of a perceived disruptor in the AI space out of China. The Chinese star-up named 'Deepseek' was flagged as offering a competitive product against more established models, but at a dramatically lower cost and being entirely open source. Due to its direct impact on mega-cap tech stocks in the US, headline moves in US equity markets were sizable. However, wider impacts were quickly retraced, with reports suggesting that the model itself is largely trained using competitor products, limiting the actual jump in innovation that was first expected. Nevertheless, in reality, the newsflow is only material for a handful of tech stocks, so from a credit perspective, we see little downside from such a development.All in all, we tend to try and look through start of year volatility or trends as large-scale repositioning can drive moves that warrant fading rather than putting weight behind. That said, rates and FX markets took the brunt of this start of year volatility, whilst credit volatility remained subdued and continued its impressive streak of resilience against macro uncertainty despite spreads being at historical tights. We see this as a sign of continued positive sentiment towards the strength of corporate balance sheets so continue to like accessing extra carry through spreads in quality companies. The rate repricing also opened interesting absolute and relative value entry points in duration, with European rates selling off in sympathy with US rates despite less concerning inflation outlooks. We continue to see duration tactically as an opportunity for mark to market performance.
Portfolio activity
Demand for new issues remained high throughout January. We maintained our pricing discipline as, in our view, many issuers were able to take advantage of this strong demand and issue through what we consider fair value. We added the following new issues in the corporate sector at attractive valuations:1. Buckeye Partners is a leading US oil and gas pipeline operator. The firm was taken private in 2019 with a considerable debt burden being placed on the company during this transaction. The firm's operating performance has been consistently strong allowing it to reduce its leverage since then and the credit quality will likely continue improving going forward. 2. Iren is an Italian utility company managing gas distribution networks and water services. The company has a high-quality fundamental profile appropriate for an investment grade company which made us comfortable with investing lower in the capital structure, however the rating is constrained by the sovereign rating of Italy which meant the company's inaugural hybrid bond provided good value. 3. ContourGlobal, operates a diversified portfolio (189 plants across 20 countries) of renewable and thermal generation assets with a solid client base of long-term contractually supported investment grade off-takers. It is transitioning to renewable energy and will have phased out remaining coal powered plants by 2027. Management have made a clear commitment to maintaining the BB rating which is achievable. 4. Teleperformance is the largest global player in outsourced customer relationship management. H2 2024 results have shown consistent growth however it is a company that investors view with caution due to AI disruption. The company will be able to maintain metrics appropriate for the BBB rating while the bond priced in line with B+/BB- peers which we felt was materially overstating the risks posed to the company. 5. La Poste, the French courier service, issued a hybrid bond. We do not expect the company's subordinated debt to receive government support in case of distress however as a standalone the company has a strong investment grade profile making us invest lower in the capital structure. 6. Aareal Bank, German-based commercial real estate lender, has been actively managing its US office exposure and disposing of non-performing loans. The bank has a high capital buffer compared to regulatory requirements. This will be further bolstered by a EUR 2bn capital gain from the sale of its Aareon business, though most proceeds are expected to be distributed to shareholders over time.7. Ambipar Participacoes e Empreendimentos (AMBIBIZ) is a Brazilian waste management company providing environmental solutions (such as recycling and carbon offsetting) and 71% of Ambipar Response focused on emergency management and environmental crisis. This position adds some diversification to the fund with the emerging markets exposure. While there were fewer opportunities in the primary market due to unattractive valuations, we saw compelling opportunities in the secondary market. We took advantage of the underperformance of French financial companies to add in high-quality names that are trading at, in our view, overly cautious levels for their credit fundamentals, namely SCOR (French insurance firm), La Mondiale (French bank) and BPCE (French bank).We took profit on Loxam (equipment rental provider), Fortune Star (Chinese conglomerate), Proximus (Belgian telecommunications services provider), Virgin Money (UK bank), Unicaja (Spanish bank) and Banco de Credito Social Cooperativo (Spanish bank).We also switched our allocation in Deutsche Bank from the bank's Tier 2 bonds, which was upgraded recently to Investment Grade, into the AT1 bonds lower in the capital structure where we see better value.
Performance and characteristics
After a very strong 2024, in January the fund underperformed its benchmark. The underperformance was driven by our positions in the Telecommunications sector and our derivatives strategies. This weakness was partially offset by our positions in the Consumer sector. The new issue market has been active but challenging, with new issues often pricing in line or through fair value. We have maintained pricing discipline, only participating where we see value.
