Key points

• Our money market and ultra-short term credit portfolios entered the violent risk aversion period at the beginning of 2020 by adopting a prudent approach.
• The price correction enabled us to take a more opportunistic positioning in the spring, while making sure that we did not hold risky issuers.
• The tightening in credit spreads was particularly marked from April onwards, bringing us back to pre-crisis levels, sometimes at even narrower levels.
• The need for funding from the financial markets is expected to remain abnormally low on the short-term segment during the first months of the year, limiting premium to low levels.
• In an environment of major support from the Central Banks, we consider it appropriate to slightly extend the maturity of our investments in this segment by placing a share of the liquid assets, when it is possible, in securities with a residual maturity of 2 to 3 years, where the slope of the yield curve appears to be less daunting.

Prudent positioning at the start of the crisis

Increase in WAM* at the beginning of 2020, caution on WAL*

The vigilance demonstrated by the Central Banks with regard to worldwide growth potential and the increasing awareness of the approach of the pandemic prompted us to progressively increase the rate duration (WAM) in our portfolio during the course of the year. This increase has intensified as the market environment has become increasingly risk-averse. This strategy enabled us to soften the fall in prices during the high-stress period of February and March.

This was because the spread widening was generalized during Q1 and did not spare any of the maturities on the fixed income and money market curves. Unsurprisingly, during the market turbulence, the biggest corrections were on fixed income securities having more than one year of residual maturity, and this contributed to the drop in performance of the money market funds.

In March 2020, the money markets were badly hit, but our funds kept their liquidity promise

The exceptionally high uncertainties caused by the sudden shutdown of the world’s major economies during the first lockdown led to fears of corporate defaults and an urgent need for liquidity for companies. The complete freeze of the fixed income market shifted the pressure to assets that still remained liquid and were less depreciated, i.e., among others, money market funds. Following in the wake of certain banks, which received numerous requests for redemption of deposits from their customers, the money market funds were able to withstand a relatively large wave of redemptions over several days.

With respect to our portfolios, we have preserved a large proportion of readily mobilizable assets (bank deposits and money market funds).

 

Opportunistic approach adopted on coming out of the crisis

 Unfailing support of the Central Banks

The Central Banks intervened several times last year, adjusting their monetary policy to the evolving health crisis. First, with sharp reactivity after their initial intervention they continued to take measures to prevent a financial crisis from compounding the health crisis and economic crisis that we were already going through.

In practice, this means that many Central Banks revised their key rates downwards, supported the banking sector and deployed massive asset purchase programs.

Specifically, in the Eurozone, the European Central Bank (ECB) intervened to stabilize the financial markets by injecting liquidities and allowing banks some leeway on their regulatory ratios. The ECB also restored confidence in the financial markets by implementing a broader range of asset purchases (PEPP**) and by special financing operations that granted funding to banks at exceptionally favourable conditions (TLTROs).

 

Fall in prices in early spring

The chaos on the markets triggered falls in prices across the board on money market and fixed income instruments until April. For example, a money market instrument in euros in the banking sector with a maturity of 1 year, with an A-2 credit rating, went from an average yield of -0,30% at the beginning of March to 0% in May.

This was also reflected on all the EURIBOR rates, as shown below for the 3-month maturity, reflecting the temporary stresses on the interbank market:

Source: Bloomberg. Data as on 31 December 2020.

 

Our post-crisis positioning

At this time, in view of the fact that monetary support was still very strong, we seized various opportunities on the market, focusing especially on issuers from the sectors most resilient to COVID-19 and strongly supported by the ECB.

For example, in the case of Groupama Ultra Short Term Bonds, at the end of April we purchased a January 2021 bond issued by APRR (Autoroutes Paris-Rhin-Rhône) with a yield of 0.7% and, in early May, a March 2021 bond from British Telecom with an offered yield of 0.8% (see below for the bond yield evolution over the course of 2020) while shedding bonds issued by Renault.

Source: Bloomberg. Data as on 31 December 2020.

At the same time, we took care to avoid the more cyclical sectors, such as the automotive sector, for example by shedding Renault or Fiat securities from the Groupama Ultra Short Term Bonds fund.

Of the cyclical sectors, the banking sector constitutes an exception: the announcements of the ECB provided targeted support to this sector, including by means of borrowing conditions from the Central  Bank that were considered attractive and through the easing of regulatory ratios. In this sector, we continue to prefer issuances of senior debt from leading national players.

As a result, we have witnessed a positive performance trend lasting several weeks on the money market funds, for the first time since 2016.

 

Return of expensive prices at the end of 2020

Rarefied supply of securities

Government recovery plans, the prospect of an end to the crisis and the return of inflows to the money markets have led to a progressive and almost entirely smooth easing of risk premiums.

However, with regard to the short-term markets, the inflows of liquidity into the markets, combined with easy funding for the banks, is upsetting the balance between supply and demand when it comes to short-term securities.

Today, we are witnessing a form of “disintermediation” of the markets by the ECB. The ECB is providing banks with an almost unlimited source of funding for about 50% of their loans, under very aggressive conditions with a maturity of 4 years: over the last few months, the yields offered by the banks on the primary market have collapsed for the shorter maturities.

As seen above, at the end of 2020, the Euribor 3-month rate is below the deposit facility rate offered to banks by the ECB (-0.50%). Since bank issuers constitute the largest portion of our investment universe, the knock-on effect on issuers from the non-financial sectors is very marked.

Ultimately, today, many issuers can obtain funding at lower levels than the deposit rate on the shorter maturities.

 

What is our positioning today?

WAL cursor raised at the beginning of the year

This situation is expected to continue into the first quarter of 2021, with very little activity on the money market by the banks, and this is expected to keep down the yields offered on the 2-year regulatory horizon of the money market funds.

By contrast, the hopes of wide-scale vaccination and resulting herd immunity could prompt the ECB to give notice at the end of Q1 that certain accommodative measures for the banking sector will not be renewed beyond the horizon of 2022. This expectation is one of the reasons for the difference in offered yields that we have observed on the 2-/ 3-year maturity segment of some issuers compared to the shorter maturities.

Consequently, we are confident that we can apply a more offensive strategy on our credit duration (WAL), at least during the first quarter. That said, the first signs of money market normalization will be the signal to trim our sails and wait, before subsequently repositioning at less expensive rates.

 

The attractiveness of the 2-3 year segment

In consistency with this eviction effect generated by the ECB on shorter maturities and the ensuing reduction in volatility, we are looking for attractive opportunities wherever possible in terms of the risk / reward trade-off on instruments with longer maturities.

On our money market portfolios, our ability to take advantage of this situation is restricted due to the maturity limits imposed by the regulations. On the other hand, we have greater room for manoeuvre on our ultra-short term bond fund, Groupama Ultra Short Term Bonds, which, unlike the money market funds, is permitted to operate in the 2-/ 3-year zone, where there are a large number of rewarding opportunities in relative terms.

For that reason, for investors having a few months of visibility over their liquidities, we recommend opting for a portfolio allocation slightly more weighted towards bonds (less money market instruments), where, although the risk may be higher, it remains close to that of money market funds and is under control, as is the case for Groupama Ultra Short Term Bonds. This fund mainly consists of securities eligible for ECB support. We consider the issuers concerned to be of high credit quality for maturities of less than 3 years.

For Groupama Ultra Short Term Bonds (WAM limited to 6 months and WAL limited to 18 months), we are targeting a net performance close to zero for 2021, or approximately 40 basis points better than a classical money market fund.

Summary of performance of our funds and of their benchmark :

Source: Groupama Asset Management, dated 31 December 2020 Groupama Entreprises I-C – FR0010213355, Groupama Monétaire I-C – FR0010582452, Groupama Trésorerie I-C – FR0000989626, Groupama Ultra Short Term Bonds I-C – FR0012599645. EONIA capitalized: benchmark index of the funds. Performance relative to Eonia capitalized.

Past performance is not a reliable indicator of future performance

 Note:  the main risks associated with the funds mentioned are interest rate risk, credit risk, liquidity risk, capital loss risk and derivative instrument risk.

 

Money market regulation: overhaul of the money market benchmark rates

ESTER replacing EONIA

After the scandal of manipulation of the interbank rates in the past, the European Union decided to change their calculation methods, in order to establish these rates on the basis of actual recorded transactions instead of on the declaratory.

The EONIA reference rate, which is determined on the basis of declarations by the banks of the rates applied on the interbank market, is therefore due to be replaced and even to disappear on 3 January 2022. This replacement is especially necessary given that the constraints now imposed on banks for short-term financing have reduced the size of the market for interbank transactions, and so, with this reduction in volumes, the EONIA reference rate has tended to reflect mainly the transactions of the French and German banking institutions.

So, on 2 October 2019, ESTER (or “€STR”) became the new risk-free rate, calculated on the basis of actual transactions weighted by volume. ESTER will be more reliable and more representative than EONIA and will be calculated from the data of 52 Eurozone banking institutions, compared with only 28 for EONIA, and will also cover more significant volumes.

We are currently still in the transition period, during which EONIA continues to be calculated (it is set to ESTER + 8.5 bps). At Groupama AM, we will use this transition period to transfer our money market EONIA reference rates to ESTER.

 

EURIBOR maintained but revised

EURIBOR has also undergone a methodological overhaul and now also includes data from actual transactions in its calculations. However, it is not scheduled for replacement. It is now slightly more volatile than before, and, without doubt it now provides a better reflection of the valuation of interbank transactions.

 

 

* WAM (Weighted Average Maturity): the weighted average maturity corresponds to the interest rate sensitivity, expressed in days WAL (Weighted Average Life): the weighted average life corresponds to the credit sensitivity, expressed in days.

** PEPP: Pandemic Emergency Purchase Program, the last asset purchases program launched by the ECB in 2020.

 

By Boris Nesme, Product Specialist at Groupama Asset Management.

Disclaimer

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Past performance is not a reliable indicator of future performance

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Edited by Groupama Asset Management – Headquarters: 25 rue de la ville l’Evêque, 75008 Paris – Website: www.groupama-am.com.