#Análisis
7 min 4 October 2023 Groupama AM

1/3 Short Term solutions – Anticipation is key!

Our forecast for a shift from monetary policy to a more restrictive approach after ten years of easing came true in 2022.

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SUMMARY

  • Our forecast for a shift from monetary policy to a more restrictive approach after ten years of easing came true in 2022. In the Euro zone, liquidity, which had been historically abundant thanks to long-term refinancing operations (TLTROs[1]) that supported the economy during the health crisis, has decreased considerably.
  • The good understanding of the European Central Bank decisions and their impact on the market are key in the management of short-term solutions.
  • Our Money Market, short-term and absolute return funds met the objective of protecting investors’ assets[2].

A PARADIGM FOR CENTRAL BANKS

Very early in 2022 and contrary to what central bankers claimed, our analysis of the impacts of major ongoing transitions in the global economy enabled us to anticipate the resilient nature of inflation and incidentally the need for Central Banks to adopt a restrictive monetary stance. The strength of the investments needed to accompany major transitions in the world and the aging of the population, complexify the role of central bankers, the only ones trying to slow down the economy. The fight against excessive inflation is probably not over given the persistent tensions on the labour markets in Europe and the United States and the uncertainty about the evolution of commodity prices in the coming months.

 

WHAT HAD WE IMPLEMENTED IN OUR SHORT-TERM SOLUTIONS?

In 2020 and 2021, with the Covid crisis, the European Central Bank substituted markets to provide liquidity to the banking system, stabilizing markets. The ECB has therefore injected liquidity for 3 years through (TLTROs1) in parallel with keeping interest rates at negative levels.

In this context, which was very uncertain, we highlighted our short-term solutions – money market funds, short-term bonds and absolute return funds – considering that they were solutions more adapted to market volatility and more effective in seeking to protect investors’ assets.

Money market and short-term bond funds

In 2020 and 2021, in anticipation of the positive impact of the ECB’s measures in response to the health crisis, money market and short-term bond funds have implemented:

  • An offensive positioning on Credit Duration (WAL) by keeping it on stable levels despite uncertainties;
  • A selective approach to expose the funds to the least cyclical sectors, except the banking sector which benefited from massive support from central banks;
  • A preference for bonds rather than money market securities, to capture the excess yield offered at equivalent maturity.

[1] Through the Targeted Longer-Term Refinancing, the ECB is proposing longer-term loans to banks at attractive rates, thereby encouraging them to lend to businesses and consumers in the eurozone

[2] Past performance is no guarantee of future performance. Any investment carries a risk of capital loss

At the beginning of 2022, with the improvement of the health crisis, we anticipated a normalisation of monetary policy with a gradual disengagement from TLTROs and the Pandemic Emergency Purchase Programme (PEPP).[1]

We decided to let the modified duration of the funds naturally decreasing by maintaining our positions (mainly in short-term bonds) even though the ECB’s offensive rhetoric affected short-term bonds more than short-term money market securities. To protect funds against interest rate risks, we jointly implemented: new investments in short maturities (1 to 6 months) with a duration target close to 0 and implementation of interest rate swaps.

In line with our reflationary forecast, anticipating an acceleration of the ECB’s restrictive policy, we had implemented an even more cautious approach from the 2nd quarter of 2022:

  • Favouring very short maturities (less than 3 months), the premiums offered on maturities greater than 3 months seem too low given the probable repayment of TLTROs3 in 2023;
  • Continuing the floating-rates exposure, to reduce the modified duration close to 0.

Example of the evolution of our allocations in Groupama Trésorerie:

[1] TLTRO : Targeted Longer-Term Refinancing Operations

PEPP : Pandemic Emergency Purchase Programme

1
Source: Groupama Asset Management, Bloomberg, 22/09/2023

From the end of 2022, while maintaining an interest rate modified duration close to zero on money market funds given the risk asymmetry on the evolution of interest rates, we have accompanied the increase in premiums on intermediate maturities, often less than 6 months, increasing slightly the credit modified duration.

From May 2023, the premiums offered on maturities between 9 and 12 months by bank issuers seemed to finally reflect fundamentals, having increased by nearly 30 basis points compared to their level at the beginning of 2022. We have therefore reinvested on these maturities, accelerating the increase in the credit modified duration of portfolios.

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Sources : Groupama Asset Management

 

Absolute Return Fund

The almost synchronous normalization of monetary policies around the world, after such a long period of massive support, has led to high volatility, amplified by idiosyncratic[1] (US regional banks, Credit Suisse in particular) and geopolitical risks.

In this context of high uncertainties, the G Fund Alpha Fixed Income fund (Luxembourg fund) demonstrates the benefits of its management philosophy: its non-directional, market-neutral positioning enabled the fund to deliver positive returns since 2019[2]. Indeed, the strategies implemented within the portfolio have benefited from the market dislocations that have occurred and more generally from the increased volatility and dispersion observed within the indices. These strategies exploiting the technical and fundamental inefficiencies of the market (bond vs. Credit Default Swap basis, index arbitrage, Corporate vs. Sovereign, pair trading, swap spread arbitrage and credit premium arbitrage in particular7), are the main drivers of alpha. This includes:

  • Pair trading[3] strategies implemented in the energy sector, utilities, automobile and pharmaceutical sectors ;
  • The combination of Basis (cash bonds vs Credit Default Swap) and Premium Arbitrage (primary market) strategies to take advantage of market dislocations.

[1] Idiosyncratic stress is stress specific to an institution (due to fraud, a major loss, etc.). It differs from a systemic crisis, which affects all institutions simultaneously.

[2] Past performance is no guarantee of future performance. Any investment carries a risk of capital loss

[3] Pair trading: purchase of a credit cover (Credit Default Swap, CDS) from one issuer and sale of a CDS from another issuer in the same sector

Basic strategy: buy a bond + buy CDS protection

Premium arbitrage: buying a bond from an issuer on the primary market that offers a significant excess return compared to the secondary market, compared to one of its competitors, or compared to its issuance curve + purchase of CDS on index

The Core pocket, which has been affected for several months by low or even negative interest rates, has benefited from the rise in rates caused by the restrictive policies of the Central Banks, and has delivered a positive result since the beginning of the year by exceeding the Ester + 60 basis point level[1].

The Alpha pocket, based on non-directional strategies, aims to capture market inefficiencies. This leads us to perform many arbitrage transactions for which we determine asymmetric loss limits and gain targets. Thus, of the 635 trades carried out in the last three years, 80% were favourable and 20% negative. There is a positive asymmetry in the distribution of these returns, giving the portfolio an attractive risk/return ratio.

How did the funds get through this regime change?

[1] Past performance is not a reliable indicator of future performance. Any investment carries a capital risk loss.

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Past performance is not a reliable indicator of future performance. Any investment carries a capital risk loss. Performance calculations are made net of coupons reinvested, net of management fees, without deduction of any subscription and redemption fees.

 

 

For more information on our short-term solutions,

Groupama Trésorerie

Groupama Monétaire

Groupama Entreprises 

Groupama Ultra Short Term Bond

G Fund Alpha Fixed Income

 

Written on 29/09/2023

  

 

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