Flash GAFI – the opportunities will remain
G Fund Alpha Fixed Income has well handled the market turmoil, bringing its performance for 2020 back into positive territory since April.
- G Fund Alpha Fixed Income has well handled the market turmoil, bringing its performance for 2020 back into positive territory since April.
- The credit market became completely dislocated in March, opening up numerous credit arbitrage opportunities.
- The alpha(1) strategies in G Fund Alpha Fixed Income have been revised upwards recently. In our opinion, many opportunities will continue to appear for the fund in the coming months
Review of recent performance
- Sails already trimmed before the crisis broke out
- Performance during the crisis
- The share of the Alpha pocket was doubled on coming out of the crisis
Sails already trimmed before the crisis broke out
After starting the year in line with its targeted performance, G Fund Alpha Fixed Income trimmed its sails by reducing its pocket of alpha strategies as early as in February. This was because we felt that in a bullish market with little discrimination between different issues and issuers, the potential credit opportunities held out much less attractive prospects for risk-adjusted returns.
Our management approach was therefore to adopt a wait-and-see position, pending a resurgence in market volatility, by maintaining a core pocket (which contains the more liquid securities, in order to ensure low volatility of the fund) standing at about 80%. Consequently, the share of the Alpha pocket was kept in the region of 20%, with almost a two thirds of it invested in negative basis strategies (i.e. buying a bond while simultaneously buying a credit hedge via a derivative on the same issuer), thereby ensuring a very limited risk profile over the medium/long term.
Performance during the crisis
At the start of the COVID-19 crisis, the short legs of our alpha strategies functioned well (the short leg is the CDS hedge on the bond, which represents the long leg) Subsequently, the bond markets overreacted, falling dramatically, due to forced selling by numerous institutional investors and a drying up of liquidity.
So, our negative basis strategies suffered, dragging down the performance of the G Fund Alpha Fixed Income. Then came a very strong inverse movement, boosting the rebound of the fund. The evolution of our negative basis strategy on Elis provides a good illustration of the changing fortunes of the two instruments constituting the strategy. The basis (the difference in spreads between the two instruments) was initially implemented at a level of -43 basis points, which at the time was at the lower end of the historic range, and then dropped to levels that had never seen before (more than 200 basis points), before returning to positive territory of about +50 basis points today (as on 12 May 2020), representing an overall gain for the fund.
Source: Bloomberg, IHS Markit, Groupama Asset Management. Data as on 12 May 2020. Spread: credit spread, expressed in basis points
In addition, the Investment Grade(2) bonds with short maturity (< 3 years) in our Core pocket, which are the most volatile instruments in this relatively non-volatile pocket, were also caught up in the wave of selling. Here is an example for the 2023 issue from a French motorway operator, APRR (Autoroutes Paris-Rhin-Rhône):
Source: Bloomberg, IHS Markit, Groupama Asset Management. Data as of May 2020.
The share of the Alpha pocket was doubled on coming out of the crisis
So, this storm on the markets created inefficiencies in the credit universe, and our aim has been to take advantage of these inefficiencies. For example, we have gone so far as to double the share of our Alpha pocket in the portfolio, in particular by taking advantage of the spreads offered on the primary market when it reopened at the end of March.
In practice, this means that, following the announcements of the ECB, we invested in corporate bonds that will be targeted by the ECB asset purchase programmes. These positions are protected on the credit side by hedges on the iTraxx Xover(3) derivatives indexes. Aiming for these bonds to outperform the overall credit derivatives market is not a very sophisticated strategy, but it is self-evident, liquid and rapid to implement in an environment that is still subject to sudden swings.
This strategy, combined with the appreciation in value of all our negative basis strategies, enabled the fund for a time to do better than merely claw back the fund’s downward movement.
Source: Bloomberg, as on 12 May 2020 G Fund Alpha Fixed Income share class I-C EUR: LU0571101715. Reference index: Capitalized EONIA
Past performance is not a reliable indicator of future performance
Over longer investment horizons, the performance of G Fund Alpha Fixed Income and its reference index are shown below:
Source: Bloomberg, as on 12 May 2020 G Fund Alpha Fixed Income share class I-C EUR: LU0571101715. Past performance is not a reliable indicator of future performance.
The main risks associated with the fund are: interest rate risk, credit risk, foreign exchange risk, liquidity risk, capital loss risk, counterparty risk, derivative instrument risk and risk intrinsic to the use of speculative instruments.
- Credit market still dislocated
- The waves of downgrading by rating Agencies will continue to offer relative value opportunities
- Selective position on the primary market, but the underlying trends will remain
Credit market still dislocated
The overall Credit market is still far from normalized, both for cash bonds and derivatives. By their nature, funds such as G Fund Alpha Fixed Income aim to take advantage of the pricing inconsistencies resulting from this dislocation.
For example, we initiated a new negative basis strategy on a German cement manufacturer at the end of April. In early May, we took partial profit (about 60% of the position) on our negative basis strategy on the Swedish company, Intrum, after the net outperformance of this bond compared to its equivalent derivative (basis initiated at 25 basis points in September 2019 and partly sold at +324 basis points).
The waves of downgrades by rating Agencies will continue to offer relative value opportunities
Opportunities are expected to be generated by the volatility of the fixed income market and the waves of credit ratings downgrades by the rating agencies. This is especially the case of the “fallen angels”, the issuers downgraded from Investment Grade to High Yield (falling from a BBB rating to BB). Many investors will be forced to sell these securities, since they are not permitted to remain invested in High Yield instruments. These forced sales will cause bond issue prices to fall below the equivalent derivatives CDS(4) prices.
We aim to take advantage of this pricing difference by going long on the bond, expending its recovery, while also purchasing credit protection to avoid bearing specific risk on the issuer in question.
Selective attitude on the primary market, but the underlying trends will remain
After capturing generous spreads on the primary market at the end of March and in April, this movement slowed during these early days of May, with the intensification of quarterly results (“blackout period”).
Despite all the uncertainties, green bonds, which are invested in tackling the challenges of the future, such as energy transition, will remain globally more appealing than their non-green equivalents.
Opportunities to be seized in the credit universe
As mentioned above, with the recent dislocation of the markets, many alpha strategies have not yet delivered their full potential, and others will be added, in the knowledge that we have abundant liquidities ready to be deployed to seize these opportunities.
A strategy appropriate to the low-interest environment
In an environment of negative interest rates and high volatility, the search for absolute return with a relatively low-volatility approach decorrelated from the markets can make sense in fixed-income-type asset allocation.
We therefore remain confident in the investment process and in our ability to generate added value over the coming months.
(1)Alpha: a measure of the ability of an investment manager to create value through the ability to detect the securities that yield better returns over a given period than would normally be expected given their level of risk.
(2) Investment Grade: high credit quality according to the Rating Agencies (minimum rating BBB-).
(3) iTraxx: baskets of credit default swaps (CDS). iTraxx Xover: basket of CDS rated BB and BBB.
(4)CDS: Credit Default Swaps. A CDS is a derivative product that hedges against the risk of default by a debt issuer. Single-name: CDS hedging against the risk of default by a single issuer.
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This document contains information concerning G FUND – ALPHA FIXED INCOME, a compartment of G Fund (also referred to as “the SICAV”), a Luxembourg-based undertaking for collective investment in transferable securities (UCITS), covered by part I of the Law dated 20 December 2002 and constituted in the form of a “SICAV”(Société d’Investissement à Capital Variable – a European publicly traded investment company structure for open-ended funds). The SICAV is registered with the Luxembourg Trade and Companies Register under number B157527. Its registered office address is 5, allée Scheffer, L-2520 Luxembourg. G Fund was authorized for trading by the Luxembourg financial authority CSSF (“Commission de Surveillance du Secteur Financier”).
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Investment in the compartments of the SICAV involve risks. Investors must fully inform themselves of these risks before any subscription and must make sure that they have understood the present document. We recommend that all potential investors contact an advisor to determine whether this investment is suited to their profile.
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Published by Groupama Asset Management – Registered office: 25 rue de la ville l’Evêque, 75008 Paris – Website: www.groupama-am.com