G Fund Alpha Fixed Income – YTD review

31/07/2020

Schermata 2020-06-24 alle 13.33.30

Over longer investment horizons, the performance of G Fund Alpha Fixed Income and its reference index are shown below

Net YTD performance

Source: Bloomberg, as on 27 July 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:

Net performance

Source: Bloomberg, as on 27 July 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 riskcredit riskforeign exchange riskliquidity risk, capital loss risk, counterparty riskderivative instrument risk and risk intrinsic to the use of speculative instruments. 

 

Sails trimmed at the beginning of the year

After the close of the year 2019, during which the credit market was trending upwards without much distinction between issuers, followed by the beginning of 2020 with the same trend persisting, we were hoping a “true repricing” moment – which we expected, but not on this scale – would generate opportunities for arbitrage. So, the alpha pocket(1), where we place our credit arbitrage strategies, was reduced to about 20% of the fund, with more than half in negative basis strategies (i.e. buying both bond and CDS hedge(2) on the same issuer), which do not contain idiosyncratic risk.

 Until the massive fall in the markets in early March, this configuration gave the fund near-immunity, enabling it to attain a performance of +0.38% on 6 March, with the CDS hedges performing their function perfectly.

  

However, the fund was finally sucked into the downward spiral

As from 9 March, the “dash for cash” reflex of the markets resulted in massive losses of the bonds in the portfolio, without compensatory increases of the CDS, because investors were selling their bonds to obtain liquidities and not out of fear of issuer default.

  • In the portfolio’s core pocket, which contains the safest and most liquid instruments, some of the high-quality Investment Grade(3) securities lost a few figures;
  • meanwhile, in the alpha pocket, numerous negative basis strategies and discounted bond strategies were impacted by the collapse of bond prices, which were only partly offset by our interest rate and credit hedging.

Already in March, the fund was back in the hunt for good deals

However, the dislocation of the credit markets that occurred during this financial storm opened up new opportunities for arbitrages, which G Fund Alpha Fixed Income, with its very ample store of liquidities, was able to start seizing as early as on 20 March.

Following the announcements by the European Central Bank (ECB), as well as by other central banks, the fund manager invested substantially in bonds having largely defensive profiles, relatively unexposed to the effects of COVID-19 and, most importantly, eligible for the ECB’s asset purchase programmes. These operations focused particularly on the primary market, where primary market premia were attractive when the market reopened after the worst of the crisis. These long positions were initially hedged by purchasing the credit derivative iTraxx Xover(4), and then this protection was partly arbitraged towards iTraxx Main(4).

In an environment of market upheaval, this relative value strategy has the advantage of being easy to implement and easy to unwind. We also consider that this strategy has an asymmetric risk / reward profile, because the risk is reduced by the buyer of last resort, namely the ECB.

This strategy functioned well during the bounce-back phase of the markets.

 The negative basis strategy also performed well, aided by the still ongoing normalization of the credit market, as evidenced by the progression of the negative basis strategy on ThyssenKrupp 2023.

Negative basis - Thyssen 2023 (in bps)

Source : Bloomberg, SuperDerivatives. 04/09/2019: strategy launch date (purchases of bond and CDS). Data as on 17 July 2020.

 We also initiated two new negative basis strategies during the spring, on two German companies, a cement manufacturer and an auto parts manufacturer.

In addition, we took partial profit on our negative basis strategy on the Swedish company Intrum.

 In the end, activity was intense, with a high turnover of instruments entering and leaving the portfolio. The weight of our alpha pocket was significantly increased during the spring, averaging around 30-35%, and sometimes even temporarily reaching 40%.

 As a result, the fund recovered from the slump within only a few weeks, reaching a high point on 21 April, taking its net YTD performance for 2020 to 0.72%.

  

Portfolio positioning

 Here the portfolio breakdown :

Core / Alpha

Source : Groupama Asset Management. Data as of 20 July 2020.

  

Outlook

Performance potential

The fund’s performance has somewhat decreased since its April peak. The main reason for this is the outperformance of the credit derivative market relative to the bond credit market. Thus, we believe that our current strategies have significant upside potential, expecting a relatively good performance of our credit derivative protections, as we have seen in recent days.

Relative value opportunities to be seized in the credit universe

As the credit market remains dislocated, it offers potential investment opportunities for our fund, given that we have abundant liquidities that can be rapidly invested. Also, the deterioration in the credit profile of many issuers could cause the Agencies to downgrade their credit rating to High Yield(3), an event that often leads to differences in valuation between the credit bond and derivative markets.

 

A strategy appropriate to the current market environment

In an environment of negative rates and high volatility, the search for absolute return with a low-volatility and decorrelated market approach can make sense in a bond-type allocation.

The fund is also well positioned in the event of a return of risk aversion, as instruments such as the iTraxx Xover, which are commonly used by investors as a hedge against an increased risk of macro outlook deterioration, work well in such a scenario.

 We therefore remain confident in the investment process and our ability to generate value in 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) 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.

(3) Investment Grade: high credit quality according to the Rating Agencies (minimum rating BBB-). High Yield: rating granting by the Rating Agencies strictly below BBB-.

(4) iTraxx : baskets of credit default swaps (CDS). iTraxx Xover: basket of CDS rated BB and BBB. iTraxx Main: basket of CDS rated Investment Grade

 

Disclaimer

This document is not intended for “non-professional” European Union investors, as defined in “MiFID” (EU Directive 2004/39/EC dated 21 April 2004) or any other local regulation. Similarly, in Switzerland, this document is not intended for investors not classified as “qualified investors” under the applicable legislation. As a general rule, this document must not be transmitted to private clients or individuals as defined in any legislation, nor to “US Persons”.

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”). 

Investors are advised that not all compartments of the SICAV are necessarily registered, authorized for commercialization or accessible to all investors in all jurisdictions. Before subscribing to a compartment, the client must take due note of the complete prospectus of the SICAV and of its latest annual and half-yearly reports and its articles of association. These documents are available free of charge at the registered office of the SICAV or at the registered office of the authorized representative accredited by the competent authority in each jurisdiction concerned.

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.

The performance of a compartment is not guaranteed but can vary both upwards and downwards. The past performance of a compartment is not a reliable indicator of the future performance of the same compartment. Performance is quoted excluding the costs and commissions charged for subscription/redemption.

This document is not an investment recommendation. Similarly, this document does not constitute an offer of purchase or request to sell in countries where the compartments of the open-ended fund are not authorized to be traded or where any such offer or request would be illegal.

The commercial teams of Groupama Asset Management, the G FUND management company, are at your service if you wish a personal financial recommendation.

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