A look at Echiquier Credit SRI Europe
The extent and speed of the rise in interest rates has been without precedent in our “young” monetary zone. And adding to an already complex environment, risk premiums have increased strongly for most of the year. The hit taken has been unprecedented. In this hostile environment, Echiquier Credit SRI Europe successfully outperformed its benchmark index by 2 points, although the absolute performance of -9.3% (A units) is hardly satisfactory.
The background
None of the usual performance drivers were present in 2022. There are a variety of reasons for this, starting with the war between Russia and Ukraine, and the resulting worries about European energy security. These events came on top of rampant inflation, exacerbated by the rise in commodity prices and logistics issues in the wake of the pandemic.
Against this backdrop, central banks across the world have racked up 350 rate hikes since the start of 2022 in an attempt to slow inflation. Long-dated bond assets obviously suffered more.
Accordingly, bond segments are showing losses for 2022 of a magnitude rarely seen – of 5% for short-dated assets, 10% to 15% for high-risk assets and investment grade corporate debt with medium maturities, and up to 20% for long-dated sovereign debt.
The natural counterparty to this is better carry. At the end of the year, yields remained close to the highs of the last decade at around 4% for investment grade issuers and 7-8% for high yield debt, providing grounds for greater optimism looking forward!
Transactions
Mobility was called for in 2022, primarily on three fronts: aggregate risk taking, management of the fund’s duration, and issuer rotation.
In particular, the management team raised the risk of the high yield segment of the fund. The weighting of B-rated companies was 5% of the fund as at 31 December 2022, whereas this rating tranche was more or less absent previously.
Rate volatility is certainly back after a decade of absence, slumbering under the impact of extremely accommodative monetary policy. Partial hedging of interest rate risk was used to buffer some specific hits. In parallel, the fund extended maturities within the investment grade component. The share allocated to issuers rated AA and A is reaching historic highs, as is its duration.
All of these moves resulted in significant issuer rotation. Echiquier Credit SRI Europe has thus included 40 new issuers since the end of 2021, whilst 30 have left the portfolio. In addition, the fund benefited from being more or less absent from the real estate sector, which was severely impacted by the cycle of interest rate hikes.
Investment strategy
The rise in rates carried out last year in conjunction with expanding risk premiums has meant that yield has returned to the bond market, a paradigm shift versus the last decade of low or negative rates and crushed risk premiums. With a yield of 4.7%, your fund is better equipped to cope with heightened volatility in the bond market.
The bond component is gradually returning to its natural state, i.e. when rates tighten, risk premiums relax, and vice versa. For this reason, we are constructing a portfolio where the balance is based on exposure to high-quality bonds with longer duration, and more dynamic exposure to high yield securities. Balance and agility are the essence of our investment strategy for the coming months with a common denominator: the search for yield.