Market backdrop
The global economy performed steadily in 2023 despite the ongoing effects of tighter monetary policy and elevated energy prices. Much of that was down to the resilience of the US, which grew more quickly in 2023 (2.5%) than in 2022 (2.1%). China also picked up pace over the year (albeit well below expectations) as it emerged later than others from COVID restrictions.
Fixed income markets, while making gains in aggregate, nevertheless struggled in an environment of still-high inflation and ongoing hikes in interest rates. Developed market sovereign bond yields were on a rising trend for much of the year, with the ten-year US Treasury issue hitting 5% in mid-October. Thereafter, however, yields fell back sharply on hopes that looser monetary policy was around the corner. The main outlier was Japan, which saw flat returns amid continuing market intervention by the central bank.
Corporate bonds outperformed sovereign bonds as credits spreads tightened amid broad optimism about resilient company fundamentals. Investors were attracted by the higher yields on offer despite the rises in the risk-free rate. This robust demand more than offset the strong wave of new issuance that hit the market over the course of the year. Returns were strongest among the lower-rated, higher-risk segment of the investment-grade corporate bond market.
Watch our 2023 Fund overview video from Thomas Chinery, Portfolio Manager of the Climate Transition Global Credit Fund.’
Recouping many of the sharp losses suffered in 2022, the Fund posted a strong total return in 2023, despite the generally weak performance of the underlying government bond markets. The majority of the gains were generated in the final three months of the year as the market rallied on guidance from the main central banks that the peak of policy tightening had been reached and that interest rate cuts in 2024 had come into scope.
The Fund’s returns were ahead of its benchmark in 2023. In broad terms, the Fund’s cautious positioning in terms of interest rate sensitivity and credit risk led it to outperform at times of market weakness – such as during the third quarter when central banks indicated interest rates were likely to remain higher for longer – and underperform when risk appetite was strong.
While the Fund held a preference for financial issuers, it was not exposed to any that were embroiled in the mini banking crisis in the US in March. Relative returns were also supported by not holding energy companies as oil prices fell back. At the credit quality level, the Fund was underpinned by its overweighting of outperforming BBB-rated credits, which represent the most risky tranche of the investment-grade universe.
Going into 2023, heightened fears of recession across the developed economies and expectations for further hikes in interest rates led us to position the Fund cautiously. Therefore, as bonds matured, we usually opted to reinvest the proceeds into more defensive areas of the market.
We did, however, note that there was value in the market after a torrid year in 2022 and that company fundamentals were generally holding up better than expected, with fewer credit-quality downgrades than the market had feared. This led us to tactically raise the Fund’s risk profile in response to changes in risk appetite and market expectations on interest rate policy.
At the sector level, banks represented the main exposure in absolute and benchmark-relative terms. Against an uncertain macroeconomic backdrop, we saw banks as being well positioned for upcoming pressures, which we felt were not reflected in relative yield spreads. Revenues were supported by higher interest rates and bond market volatility. This enabled banks to control earnings allocation – to help support regulatory capital requirements, to build provision against future expected loan losses and to Fund stakeholder distributions.
The main way in which we expressed risk in the Fund was via the overweighting of the more risky BBB-rated sector. To help hedge against volatility in credit spreads, we maintained an off-benchmark exposure to US Treasury bonds.
We have learnt to expect the unexpected. Whilst inflation will likely tick down and rate hiking cycle will likely turn into rate cutting cycle, we believe that rate and spread volatility may well pick up. For this reason, directional spread compression will probably not be a big driver of returns in 2024 being the tight levels entering the start of the year. However, we do believe there is sufficient technical support for investment grade credit and carry could very well deliver robust returns, and fundamentally will be a very important part of a credit portfolio going thought the next few years.
Company fundamentals remain strong, defaults are not expected to pick up, the macro backdrop has already sparked moves into credit and, in investment grade supply/demand technicals suggest demand for credit will be robust and plentiful going forward – not forgetting the power of carry.
Carry is a term used by Fund managers to describe the interest that comes into a Fund from owning bonds that pay coupons (or equity that pays a dividend). In bond land, coupons paid on bonds are now significantly higher than they have been over the past decade and thus when coupons are paid into the Funds, the manager has a lot more cash to reinvest.
Because money market strategies have been so attractive over 2023, in comparison to investment grade, there hasn’t been that flood of investment into credit that we imagined back at the start of 2023. In turn, investors have been turning to duration and investment into IG credit. The continuation of this provides a supportive backdrop for IG credit and already spreads have materially tightened as a result.
Essentially, the longer these higher coupons are being brought into Funds, the more cash the Funds generate each time there is a payment – compare 1.5% in 2019 and 2021 vs 6% going into 2024. Therefore, there has to be more investment into the credit market providing that second line of support for IG prices. Absent anything else, this generates positive structural support from inflows and positive structural support from higher coupons.
We remain supportive on the higher for longer narrative, given inflations’ journey down will likely not be a smooth one. We appreciate the markets rush for duration, but given inflation will likely remain sticky, we believe cuts will probably be pushed out. Spreads on the other hand, are looking a little rich. Peak interest rates, soft landings and a benign macro environment is fully priced in and while credit market technicals are sound, this makes us cautious on valuations and wary of extending our credit exposure too far down the credit curve, both in terms of duration and quality.
Fund Name: AI Climate Transition Global Credit Sec ID: LU2299074091Benchmark Name: Bloomberg Global Aggregate Corporate Hedged IndexReporting Currency: USDInception Date: 05/05/2021Report To Date: Results at: 2023-12-31
1M
3M
6M
YTD
1 Year
2Y Ann
3 Years
3Y Ann
Since Inception
S.I Ann.
Return
3.64
7.03
5.51
8.56
-4.22
-
-8.05
-3.11
Benchmark
3.81
7.53
5.79
9.10
-3.20
-7.04
-2.40
-4.94
-1.89
Relative Benchmark
-0.17
-0.47
-0.26
-0.49
-1.05
-3.27
-1.25
Past performance is not a reliable indicator of future performance.
Performance basis: Mid to mid, in the share class reference currency, gross of tax payable by the Fund with income reinvested. Net figures are net of ongoing charges and fees. Net and Gross performance does not include the effect of any exit or entry charge. The Fund's performance is compared against the Bloomberg Global Aggregate Corp (the “Benchmark” or the “Index”). The reference benchmark is not aligned with all of the environmental or social characteristics promoted by the Fund.
Note for UK Investors: This Fund is domiciled in Luxembourg and is authorised by the Commission de Surveillance du Secteur Financier (CSSF). The Fund is recognised in the UK under the Overseas Funds Regime but is not a UK-authorised Fund and therefore is not subject to UK sustainable investment labelling disclosure requirements. UK investors should be aware that they can make a complaint about the fund, its management company, or its depositary. However, complaints may not be eligible for resolution by the UK’s Financial Ombudsman Service and any claims for losses related to the management company or depositary will not be covered by the Financial Services Compensation Scheme (FSCS). UK investors should consider seeking their own financial advice before making any decisions to invest and refer to the scheme prospectus for further information.
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