Update on... Echiquier Credit SRI Europe February 2024
Bondholders are breathing a sigh of relief: the lights are green in all segments. Whether high-quality corporate debt or more heavily leveraged balance sheets, performances were excellent in 2023. It was a very good year that enabled Echiquier Credit SRI Europe to make up ground.
Operations
Economic outlook
A bond’s annual return depends essentially on three factors: the actuarial yield (or carry), changes in risk premiums and changes in risk-free rates. In 2022, the latter two factors had a negative impact on the performance of funds and indices, while the actuarial yield was too low to absorb shocks. Bond indices accordingly lost between 5% and 19% of their performance – Iboxx Corporate 1-3 year and Bloomberg EuroAgg Treasury 7-10 year indices.[1]
In April 2023, we highlighted the improved visibility offered by carry, which was once again attractive. It has to be said that the markets were again more forgiving than expected. Bondholders benefited not only from historically high yields, but also from a tightening of risk premiums and yield curves, which amplified the rebound in bond returns.
However, a shock on the scale of 2022 cannot be wiped out in just a few months. High-yield debt is the only asset class that has returned to its level of the third quarter of 2021. The situation is more difficult for investment-grade indices, which are still between 5% and 8% below the same starting point, or for long-dated government bonds, which are more than 10% below.[2] Echiquier Credit SRI Europe, which is mainly invested in Investment Grade debt, is making up ground, and while it has not yet returned to its highs, it is getting close.
Fundamentals
The fund continued to favour longer-dated debt during 2023. The scale of the movement was considerable. Interest rate sensitivity had reached a low of close to 2 in 2021, contributing to the relative outperformance of 2022. After successive increases, it reached an all-time high of 4.3 in October last year, in line with the pressure on long-term interest rates. This allocation decision was based on two pillars: firstly, the conviction that markets were overestimating future policy rates and, secondly, a very favourable view of the risk-return profile of investment-grade debt. To finance this movement, exposure to high-yield debt was reduced, bringing it close to the 20% mark for the Fund,[3] a level not seen since 2015.
In addition, we are selective in our exposure to the high-yield segment, which still benefits from carry, which can absorb shocks in the event of sluggish growth, but would no doubt suffer setbacks in the event of a sharp recession.
Investment strategy
The strategy for 2024 is focused on increasing exposure to moderately high-duration investment grade bonds. In our view, yields on the various bond classes remain attractive, despite the partial catch-up in performance over 2023, in line with the increased visibility on the macroeconomic and monetary policy fronts.
Our dynamic approach aims to take advantage of credit market volatility, which creates opportunities. We therefore remain vigilant, and will adjust our positioning and issuer selection in line with changes in the environment. Balance and agility will remain the essence of our strategy over the coming months, with the search for yield as our compass.