Market volatility, declining oil prices and a drop in liquidity is currently impacting the performance of our corporate bond funds. This has led to the introduction of a swing price of 2% in certain funds. For a number of reasons, however, we expect markets to normalize in the beginning of 2015.
In an overall very volatile market, our Sparinvest High Yield Value Bonds fund is down approximately 12% YTD. This is naturally not satisfactory, but it is important to stress that the general High Yield market as a whole is subject to a “perfect storm” caused by a number of macroeconomic factors.
In our latest “Letter to Shareholders” from 3rd Quarter 2014, we explained the origins of the underperformance, which were largely related to the fall in the oil price and raw materials.
The story for December is almost the same as Q3, unfortunately just worse. A continued collapse in commodity prices and oil prices (latest price at USD 55/barrel which is a drop of -44% YTD and a 20% drop in December alone) worsens the performance, as we have a relatively high exposure to the Energy and Materials sectors.
Steep price drops derail oil companies
In fact, the oil price is now at a level where US shale drillers are losing money. Going forward we expect to see an increase in distressed companies/defaults in this sector, and it is important to highlight that we have no exposure to this area of the energy sector.
In spite of this, there are no new distressed names in our portfolios. The ones already in a restructuring process, are being hit by the hedge funds’ recent sell-off.
As mentioned, quite many extreme macroeconomic phenomenon’s are taking place at the same time, making markets very volatile, and we continue to experience very low liquidity (if any). Here some of the main factors in play:
- Russia is in full-blown currency crisis. The Ruble has fallen more than 50% since the start of the year. The Ruble’s slide has been driven by declining confidence in the central bank, sanctions by the West over Russia’s intervention in Ukraine, and the aforementioned plunging oil price.
- Greece returned to the headlines with potential elections coming up, opening up the possibility for renegotiations with IMF and the EU.
- France’s sovereign rating was cut by the international rating agency Fitch to AA.
- The bull flattening of the German bond curve continued, and 10 year Government bond yields hit a record low of 0.63% underscoring the inter-EU strains.
- Recent years’ political regulations of the (investment) banks and the clearance of balance sheets up to year-end evaporate liquidity in the secondary market. See also our “Letter to Shareholders” from 3rd Quarter 2014”.
Forced selling puts market under pressure
On top of above factors, we have also seen a sell-off in high yield corporate bonds driven by algorithmic models. This relates to two main factors:
1. Redemptions in major ETF’s.
2. Forced liquidation of some major hedge funds’ risk exposures, i.e. oil. Latin American corporate bonds were especially effected.
In other words, we are experiencing serious market impact from forced sellers. Consequently, the benchmarks are also dropping, although not in the same pace as our portfolios. This is due to our bottom-up, off-benchmark approach, and in this case particularly due to our relatively high exposure to the energy and materials sector.
Despite the above, rather negative news, we are seeing some light at the end of the tunnel when looking forward:
- Recent economic data confirms a picture of sustainable growth in US. The statement from the FOMC meeting on 17. December signaled that the Federal Reserve is likely to start raising rates in late Q2 2015.
- We expect the ECB to initiate QE in January and with a balance sheet target of EUR 1trn, the ECB will purchase corporate credits as well (rather than Greek government bonds). Our view is, that the market is underestimating the impact of this.
- The current Yield to Maturity in the fund is at 10,09%, and the distressed cases (under price 30) are not included in this calculation.
- Lately we have no new distressed names in our portfolios, and any recovery will benefit the performance of the fund.
To conclude, we expect the market to normalize in the beginning of 2015 and that the attractive carry of more than 10% the portfolio will deliver satisfactory long term returns for investors.