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How total return may help decipher the euro credit market

  • 09 July 2024 (3 min read)

Boutaina Deixonne, Head of Euro IG & HY Credit recently talked to French media, Quantalys

Read below their discussion on the euro market conditions and why Boutaina believes in this environment an active, total return approach can help find opportunities.

Where are we are on market conditions after this retracement?

In 2022, central banks, whether in Europe or the United States, began to raise rates and we were expecting to have a rather gentle and gradual rise in rates. In fact, we ended up in 2022 with a rise that was abrupt and very aggressive on the part of central banks.

So this means that in 2022, we had a very complicated year in terms of returns for the asset class, but today, we find ourselves with very attractive returns. For example, the investment grade (IG) market offers a return of nearly 4% while the high yield (HY) market offers a return of almost 6%1 . We have not seen these yields for over ten years, even though the fundamentals of some of these issuers are very solid and resilient.

If we look at the credit spread or credit premium, the situation is a little different. This is because we have seen very significant tightening of these credit spreads over the last twelve or so months. Almost half of the HY market has gone from 500 to 250bps and the IG market it has gone from about 130 to 75 basis points.

That's why at AXA IM we believe that active, conviction-based management, is important when seeking the best opportunities? Therefore, we aim to have a stable process which will allow us to determine whether it is the time to invest or not. It allows us to ask questions such as:

  • Is this the time to increase the risk or reduce the risk?
  • What are the sectors on which we want to rely? Sectors on which we want to be underweighted.
  • And then, within the sector itself, what are the names that we are comfortable with given the relative value? And then the names that we would like to discard.

What are the elements that can disrupt or improve this market for the coming months?

Central banks and their monetary policies are the obvious ones that can influence markets in the coming months. But there are also elections: 2024 is an election year in the United Kingdom, in the United States and in Europe, among other places. So that's likely to add a little bit of volatility. We expect to enter a cycle that may be less promising, which could have an impact on cyclical sectors. As a result, we think it is important to be agile and to have a flexible investment management approach to take advantage of opportunities and also to mitigate losses.

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If we focus on the primary market because it is a bit like the thermometer of the credit market. Where do we stand? Is it still dynamic?

It's a very strong market. In 2023, we had almost € 600 billion of issuance between financial and non-financial issuers which was completely absorbed by market participants. This trend is continuing in 2024. Today, we have almost € 350 billion issued. These are huge amounts in the Euro Credit market across all sectors - even in the real estate sector, which was a bit shunned last year. Real estate issuers are now able to issue across all seniorities.

Whether it is senior debt, subordinated debt, perpetual debt or the famous AT1, we have a very dynamic market. There are also a lot of US issuers coming to take advantage of the buoyant environment in the European market. So, it's a very dynamic, very healthy market that's functioning well and therefore liquidity conditions are extremely good. But again, having flexibility, analysing companies, means that we don't invest in everything. There are companies that we are positive on, that we go into with spread levels in mind or with yield levels in mind, and then there are other companies where we have to be careful. We think it is important to be selective.

And when we talk about a Total Return Bond strategy on credit, what performance drivers are we talking about?

At AXA IM, we have a total return strategy that has seen strong inflows in recent quarters and months. It aims to provide investors with flexibility, diversification and liquidity, while taking a simple, vanilla approach. For example, we don't invest in fund of funds, securitised assets or very complicated security types.

Duration is one of its key performance drivers. With a range of -2 to +6, the investment team has a lot of flexibility to adjust the duration according to our convictions.

The second performance driver is our ability to allocate between investment grade and high yield. While it must remain an investment grade strategy, it can go up to 50% in high yield. This allows us to seek attractive yields while remaining an investment grade strategy. We also use derivatives, such as futures, to manage duration or credit derivatives to adjust credit beta.

In conclusion, can we look at short duration because for a long time it was not necessarily very interesting. Why is it interesting today?

Some investors are interested in having a barbell strategy - a total return strategy that is very flexible and then a strategy that is very defensive. Four years ago, we wouldn't have talked about short duration. But today, with the inversion of the curves, with this normalisation of rates, we have a return on the short end of the credit curve that is almost equivalent to long duration, but with volatility that will be almost half as high. So, it's really something quite new that we have today.

So we are taking advantage of this aberration to be able to play this short segment as well.

Exactly. And in that part, we may benefit more from the secondary market than the primary market, but it makes perfect sense because it's still a liquid market with interesting financial conditions. 

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