Money Market: what investment solutions opportunities in the current interest rate environment?

Key points

• In line with our central macroeconomic scenario, we expect growth rates will be resilient in Europe and the US in the coming years and will lead to “higher for longer” interest rates.
• In this environment, we believe European and American yield curves might steepen through the rise of long-term interest rates and the stabilization of short-term maturities with an asymmetric risk to the upside.
• With a rising volatility on fixed income markets and short-term yields becoming attractive, we believe our Money Market, short term bonds et absolute return strategies might be relevant to address 2024 challenges.

 

A non-consensual central scenario

Our main macroeconomic scenario is based on massive investment needs to address the energy transition and the strategic sectors independence.

These structurally inflationary transitions are triggering a mandatory adjustment in monetary policies around the world: Central Banks must act to keep the economy growth under control and get inflation rates back near their targets. However, the strength of investment and the productivity gains it is generating should lead to positive economic growth rates and profits. We believe there might still be casual periods of economic slowdown or recession, but we stay optimist on the longer term for three main reasons:

• The investment “boom” requires many recruitments and will give households the visibility they need to consume.
• A new cycle of innovation, for example with the rise of Artificial Intelligence.
• Expansionary public policies that benefit from the gradual rise in the cost of debt and growth rates expectations that might be, according to our central scenario, higher than expected.

” the strength of investment and the productivity gains […] should lead to positive economic growth rates and profits “

 

What solutions to address the challenges in this environment?

Money Market and short-term bonds

Fixed income markets greatly benefited from the interest rates rise started by Central Banks. In Europe and in the US, the yield curve remains inverted, making money market yields attractive.

If we look at the historical periods of inverting yield curves in Europe and the in the US, they frequently normalized thanks to an economic slowdown, consequence of a more restrictive monetary policy from Central banks. These periods of economic contraction were followed by monetary easing decisions that led to a yield curve normalization driven by the drop of short-term interest rates.

The massive investment needs and the long-term inflation pressure might lead to a more complex scenario with growth likely to remain more resilient than consensus expectations over the next few years. As a result, we are likely to see Central Bank interest rates remain high for an extended period.

” We are likely to see Central Bank interest rates remain high for an extended period “

The massive investment needs and the long-term inflation pressure might lead to a more complex scenario with growth likely to remain more resilient than consensus expectations over the next few years. As a result, we are likely to see Central Bank interest rates remain high for an extended period.

In that scenario, the yield curve steepening might come from the rise of medium and long-term rates, that already partly occurred.

 

Diagram of a bear steepening scenario¹

As part of a cautious investment approach to interest rates, we believe it is better to focus our strategy on products with a low volatility profile, like money market or short-term bond investments.

Short-term bond mutual funds also offer attractive features in an environment of increased volatility:

• Greater flexibility than money market funds in managing credit and interest rate risks.
• A short-term approach to limit exposure to bond market volatility.

 

Absolute return

This likely increase in volatility raises our interest in absolute return strategies to be able to capture a positive performance in various market conditions.

Absolute return mutual funds have characteristics addressing this objective:

• The ability to capture a positive performance in various market conditions thanks to a “market neutral” approach.
• A risk management approach with respect of predefined metrics.
• Exposure to the convictions of the management team, with strategies not constrained by a benchmark index.

In these strategies, the alpha is coming from arbitrage operations, by identifying and exploiting technical and fundamental inefficiencies in the market.

Decorrelation – Risk management – Convictions

 

Groupama AM investment solutions to try to benefit from these opportunities

Money Market and short-term bonds

Groupama AM’s three money market funds are currently positioned to take advantage of the market conditions we previously mentioned and our outlook for the coming quarters:

• Maintaining a very low sensitivity to interest rates by adopting a variable interest rates strategy to protect the portfolios against a possible upward revision in short term rates.
• An increase in the WAL³ of the three portfolios, by investing mainly in securities close to 12-month maturities to benefit from the end of the TLTRO programs and the reconstitution of risk premiums on these maturities (around 30 basis points).
• An increase in high quality European banks, which are the main issuers we consider attractive around a 12-month maturity.
• A preference for peripheral European bank issuers, particularly Spanish, whose risk premiums have become more attractive in relative terms compared with bank issuers in core countries such as France and Germany.
• Investments made almost exclusively in money market securities, at the expense of bonds, which are relatively more volatile and less profitable in this environment.

 

Groupama Ultra Short Term Bond has a more dynamic investment philosophy but maintain risk and performance characteristics close to Money Market funds.

This mutual fund aims to capture a higher potential performance compared with Money Market funds thanks to a higher flexibility in the management of its WAL⁴ and WAM³, the ability to invest in bonds up to 36-month maturities and a greater diversification in terms of issuers and countries.

To meet this objective, Groupama Ultra Short Term Bond is currently calibrated as follow:

• An interest rate sensitivity of 0,28% at the end of October, gradually increased in line with the rise of fixed income yields in 2023.
• A credit risk sensitivity maintained around 10 months, to benefit from high risk premiums on short term maturities, consequence of the market expectations regarding a drop in the ECB interest rates in 2024.
• An average rating of securities raised from BBB to A- over a year, to protect the portfolio against a possible deterioration of issuer’s solvability and economic conditions, mainly on the lower part of the Investment Grade issuers (BBB et BBB-).

Sources: Groupama Asset Management

*End of quarter volatility 30/09/23

 

Absolute Return

G Fund Alpha Fixed Income fund is made up of two distinct strategies, the core one and the alpha one, with the objective to deliver a non-directional absolute return.

The core strategy invests in short-term, good credit quality and liquid fixed income securities. To take advantage of the market environment, the current positioning of the fund is in line with our Money Market strategies:

• Investments in securities with a maturity close to 12 months to take advantage of the reconstitution of money market premiums following the repayment of TLTRO operations.
• A low interest rate sensitivity strategy (0,06 years at the end of October).
• A main focus on securities issued by high-quality European banks (no credit risk sensitivity at the end of October).

 

As of end of October, the yield of the core strategy is Ester + 60 basis points.

The management team benefited from the rising volatility environment in 2023 to identify and exploit arbitrage operations as part of the alpha strategy such as:

• A long relative position in long-term US inflation rate against the long-term inflation rate in Europe.
• The narrowing of risk premiums between Credit Default Swaps⁵ of high quality and high yield issuers.
• A relative short position in Italian treasury bonds (BTP) and German treasury ones (Bund).

160 arbitrage operations have been done in 2023. Therefore, the fund strategy looks attractive in a market environment we expect to be volatile in the coming quarters, which is a mandatory condition to exploit technical and fundamental inefficiencies and build a strong alpha strategy.

 

1-month yield correlation between G Fund – Alpha Fixed Income and BBG Euro Corporate 1-3 years index

Sources : Groupama Asset Management

 

The above chart shows the decorrelation between G Fund – Alpha Fixed Income and Bloomberg Euro Corporate 1-3 years index⁶. Since 2019, we have seen the correlation moving between -0,77 to +0,63. Therefore, the fund has a non-directional profile we believe might be relevant in the current volatile market environment.

Past performances are not reliable indicators of future results.

To learn more about our short-term solutions:

• Groupama Tresorerie – IC share: FR0000989626
• Groupama Monetaire – IC share: FR0010582452
• Groupama Entreprises – IC share: FR0010213355
• Groupama Ultra Short Term Bond – IC share: FR0012599645
• G Fund – Alpha Fixed Income – IC share: LU0571101715

Document written on the 06/11/2023

 

 

 

¹ Bear steepening: yield curve steepening coming from a faster increase of medium and long-term interest rates than the rise of short-term ones.

² TLTRO: Targeted Longer-Term Refinancing Operations

³ WAM: Weighted Average Maturity of assets

⁴ WAL: Weighted Average Life of assets

⁵ Credit Default Swaps: Financial product used as a hedge against the credit risk of an issuer.

⁶ Bloomberg Euro Corporate 1-3 years index is used as an illustration of the directional performance of the bond market for short- and medium-term maturities but is not the fund’s benchmark. Its benchmark is the capitalized Ester index.

 

Disclaimer

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