Fund News

Carmignac Sécurité: 2018 Retrospective & Road to 2019

by
  • Keith NEY - Fund Manager
17.01.2019

A look at our performance over the year

In the fourth quarter of 2018, Carmignac Sécurité decreased by -1.77%, while its reference indicator* increased by +0.61%. For the full year, the Fund was down -3%, while the reference indicator was down -0.29%.

A material decline in the fourth quarter capped a very disappointing year. In the second quarter, although we reduced our Italian duration before the election, we were not prepared for the re-introduction of redenomination risk into the Eurozone in mid-May’s Italian sell-off and rapid flight to safety in an already expensive German bond market. In the fourth quarter, our expectations were missed when, instead of a stabilization of recently weak Eurozone data, the deterioration in economic performance accelerated to the downside. During both quarters, the Fund’s portfolio construction and tactical shorts in German bond futures were inappropriate. In addition, the low risk side of our barbell strategy had to absorb the most negative yields yet in the government bill market as well as rising spreads in front-end credit, limiting any room for error.

Since July 2016, our portfolio construction has been consistent with our cyclical view to be bearish on bonds, preparing for a gradual regime shifting away from this prolonged period of Central Bank liquidity injections and volatility suppression. The overall portfolio construction has been focused on minimising the losses of rising rates by leaning towards short-maturity government bonds, reducing corporate spread duration and default risk, and tactically shorting longer-end German bonds. This has worked well as German 10-year yields troughed at -0.2% in July 2016 and peaked at 0.8% in February 2018, with the Fund benefiting from a positive contribution from derivatives overall in each of the three previous years before 2018. Since mid-May 2018, our hedging positions, in particular in interest rate derivatives, were a drag on performance, costing the Fund around -160bp for the year. Our early preparation for the reversal of QE’s portfolio rebalance channel minimised the losses from a very difficult period for corporate credit, where the ICE Euro Investment Grade Corporate Index lost -1.1% and the ICE Euro High Yield Corporate Index lost -3.6%. Carmignac Sécurité’s underlying government and corporate bond portfolio lost around -60bp during that period, including nearly -40bp from Italian government bonds.

Outlook 2019

With Carmignac Sécurité’s reference indicator* offering a negative yield-to-maturity close to -0.25%, but an even worse -0.54% when excluding Italy, short-maturity Eurozone fixed income is severely challenged. Since the ECB’s tax on savers started in June 2014, we have used a barbell strategy to help escape this unprecedented era of financial repression. In order to avoid the guaranteed losses on cash and front-end bonds, it is necessary to take greater risks in longer maturities or lower credit ratings. A low duration strategy that uses the entire maturity spectrum, but always within our -3 to +4 portfolio duration risk limitation, should help to support directional, carry, and roll-down driven performance in this difficult negative front-end yield environment. Offsetting this higher risk portfolio, we may have a large pool of cash, bills, and low volatility carry, if it can be found.

The sell-off in risky assets during 2018 has increased the opportunity set available in the credit markets. For example, the average yield-to-maturity of the ICE 1-3 year Euro Investment Grade Corporate Index, after bottoming at 0.07% in late 2017, has risen to 0.67% in early 2019. The lack of carry, and its repricing that dragged on Carmignac Sécurité’s performance in 2018, should support the Fund going forward. The Fund has an average yield to maturity around 0.85%. Although it is too early to jump head first into the asset class considering the deteriorating growth outlook, numerous political fights, and ongoing tightening of monetary policy, some of our favourite investments have sold off to attractive spreads described below:

  • High yield corporate bond

    Our total high yield corporate bond exposure is around 5.8% (17bp duration), with 2.7% of that maturing or likely called within the next two years. Our Altice holding company bonds are trading at an 8.5% yield-to-maturity in 2022, benefitting from the material amount of cash raised by recent asset sales. Intrum, the Swedish debt collection and credit services business, has BB+ bonds maturing in three and a half years that trade at a +500bp spread over Germany.

  • High yield government bond

    Our total high yield government bond exposure is around 3.2% (20bp duration), comprised mostly of Greek government bonds across the maturity spectrum. Substantial progress implementing structural reforms and improved growth outlook ought to drive further ratings upgrades. The maturity extension and interest deferrals on official sector debt in the Greek final program deal further enhance the effective seniority of the smaller amount of publically traded bonds outstanding, such as the 2025 maturity trading at close to 4% yield to maturity.

  • Structured credit

    Our total structured credit exposure is around 7.4%, mostly in AAA/AA tranche Collateralised Loan Obligations. European CLOs remain a broken asset class, where regulatory constraints and crisis scars allow us to benefit from attractive spread levels considering the near complete absence of historical defaults. After the recent sell-off, the average yield to our base case maturity assumptions of this portfolio is around 1.65%.

  • Investment grade corporate credit

    Our total investment grade corporate credit exposure is around 50% (64bp duration), with 46% of that maturing or likely called within the next four years. This portfolio is highly rated and short-maturity, designed to take minimal risk and offset the riskier side to our negative yield survival barbell strategy. We are invested in the non-rated senior unsecured bonds of Eurofins that are maturing in three years and trading around +270bp spread over Germany. We are also invested in FCA Bank, the captive autofinance subsidiary of Fiat Chrysler that has a funding support agreement from Credit Agricole, that has BBB+ bonds maturing in two years that trade around +180bp over Germany. The largest sector weighting in this bucket remains financials at 18% of the Fund.

  • Investment grade government bond

    • Our total investment grade government bond exposure is around 23.6% (180bp duration), including a mix of directional exposure as well as relative value and curve trades when overlayed with the derivative book. The total derivative exposure at year-end was -370bp. Although the overall modified duration of the fund at year-end, including all segments, was around -85bp, we decided to close out our net short and simplify the portfolio in early January after continued downside surprises to European data. After exiting all directional shorts in early January, and reducing the size of French and German curve trades, the overall duration of the fund is around 115bp. With reduced conviction on the direction of rates short-term, we prefer to minimize the weight of this strategy and allow the newly rebuilt carry and spread compression potential of the underlying portfolio to drive future returns.

Cash and equivalents

Cash and European government treasury bills are around 10%. Also relevant for liquidity purposes, 30% of the corporate and government bond exposure described above matures in less than 12 months.

MAIN RISKS OF THE FUND

INTEREST RATE: Interest rate risk results in a decline in the net asset value in the event of changes in interest rates. CREDIT: Credit risk is the risk that the issuer may default. RISK OF CAPITAL LOSS: The portfolio does not guarantee or protect the capital invested. Capital loss occurs when a unit is sold at a lower price than that paid at the time of purchase. CURRENCY: Currency risk is linked to exposure to a currency other than the Fund’s valuation currency, either through direct investment or the use of forward financial instruments. The Fund presents a risk of loss of capital.