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Credit Opportunities – Gregoire Mivelaz

During the second quarter, there were three positive catalysts for subordinated debt: a strong earnings season, banks calling their callable perpetuals and the primary market reopening. Gregoire Mivelaz reflects on the key events of the second quarter and explores why he believes subordinated debt could outperform high yield going forward.

What were the major recent events and impacts on your asset class?

So, one of the main events, which pretty much surprised everybody, has been the resilience of the US economy. And so, the implication has been that core inflation is much more sticky than expected. And that's why, one of the reasons why, the Federal Reserve (Fed) is so hawkish. Out of Europe, we've seen something similar. You know, the energy crisis did not materialise, core inflation remains too high. And this is why we think the European Central Bank (ECB) will most likely have to hike two more times. So, you know, if you're waiting for the pivot, you've got to wait a little bit longer. But I mean, the implication of this low growth inflationary environment is actually very good for the financial sector, okay. So, what we're seeing is rising rates are boosting profitability. And so specifically for our asset class, during the second quarter, we had three main positive catalysts. The first one being the very, very strong earnings season, which is very important in terms of vote of confidence for the sector. The second catalyst has been banks calling their callable perpetual as expected, but that was important. And third one is the primary market which reopened; so, we saw banks coming with share to subordinated debt, initially they're not really paying a premium. And just two weeks ago we had BBVA coming back on the primary market with an additional tier 1 contingent convertible bond (AT1 CoCo) and there was two times more demand than supply. So, all in all, you know, normalisation during the second quarter and some positive news for our sector.

What can your asset class offer in the current environment?

Well, I mean subordinated debt, you know, delivers or provides an income similar and actually even higher than high yield currently but from investment grade issuers and also provides very good prospects in terms of price appreciation. So, if we go to the first element, I mean, this is quality income, you know, I think investors now start to like fixed income again because, you know, it can generate a positive income. But at the same time, you know, especially forward looking, I think quality is even more important and subordinated debt is issued by very strong investment grade issuers. So, by nature, very defensive. I mean, those investment grade issuers can fund themselves with senior at very, very cheap and low levels. But subordinated debt being issued for capital and capital is expensive. That's why they're paying a lot. So once again, income like high yield, but from investment grade issuers and in term of prospect, in term of price appreciation, look, I mean, valuations are very attractive. 70% of the market still priced to maturity and everything, most of the bonds will be called. So, there's lots of additional positive catalysts that should lead to some spread tightening / price appreciation.

What is your outlook in the near and medium term?

We are cautious when we look at the macro backdrop, but we are at the same time very constructive when we look at our asset class. So, you know, we think this year investment grade issuers should outperform high yield. We think that the financial sector should outperform corporates. We think that European banks look very, very strong if compared, for example, to US banks. And so, you know, for the funds, I mean, we're capturing a very high income. So, for the second half of the year, you know, we're going to capture around 2 to 3% income independent of market conditions. But also we would expect high, potentially low double digit price appreciation. 70% of the callable perpetuals are priced to maturity. More than 70% of the bonds we own are callable within the coming three years and with spreads of around 500 basis points. You know, we think it's fair to expect some mean reverting to what we would qualify as more fair value. So very constructive and but at the same time very cautious. But once again, that's a sort of perfect environment for our asset class.

Is there one chart you’re currently monitoring closely?

So, I mean, on this chart, there's two things we think is worth mentioning and I mean, if you look on the very right, the performance of equity of European banks being plus 10% year to date, I mean, we don't really care what's happening on the equity side because we're investing in bonds. But I think it's interesting, you know, equity price of European banks being up 10% and by the way, US banks down 20%. So, you see there's something happening in Europe and the something happening is rates going up, which is good for profitability. So, sentiment toward the sector is strong. And but then if you look at a European subordinated debt, we are only up 1%. And normally when the sentiment is strong and this is what the equity market is pricing, you would expect sub debt to perform much stronger. But, you know, it's not a surprise. Take a step back after all the headlines of first quarter this year, you know, it just takes time. And I think we're pretty much at that time. The second element is versus European high yield and that's quite interesting because investors are screaming for quality and actually high yield has done very well and subordinated debt has underperformed year to date despite the stronger credit quality. But once again, because of those positive catalysts I've mentioned before, we think there's scope for subordinated debt to outperform European high yield both on an absolute as well as relative terms. So, something we'll be looking, you know, of the third and fourth quarter this year.

Important disclosures and information
The information contained herein is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained herein may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information contained herein. Past performance is not an indicator of current or future trends. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice or an invitation to invest in any GAM product or strategy. The securities listed were selected from the universe of securities covered by the portfolio managers to assist the reader in better understanding the themes presented. The securities included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers.

No guarantee or representation is made that investment objectives will be achieved. The value of investments may go down as well as up. Past results are not necessarily indicative of future results. Investors could lose some or all of their investments.

References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in indices which do not reflect the deduction of the investment manager’s fees or other trading expenses. Such indices are provided for illustrative purposes only. Indices are unmanaged and do not incur management fees, transaction costs or other expenses associated with an investment strategy. Therefore, comparisons to indices have limitations. There can be no assurance that a portfolio will match or outperform any particular index or benchmark.

This presentation contains forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of GAM or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.

Gregoire Mivelaz

Fund Manager, Atlanticomnium SA

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