It’s not just climatic phenomena that are subject to excesses. The bond market too! There have been many violent movements in the bond market in recent quarters, with one family of funds in particular – the bidirectional/flexible funds – proving particularly welcoming.
After a spectacular return to market life in 2023, DNCA Finance’s bond fund specialists consider current market conditions to be rather favourable for bidirectional (absolute) bond funds that adapt to variations rather than relying on megatrends. As proof of this, the bond markets have gone through several phases in recent months, with successive waves of violent bullish and bearish trends. And the future remains very uncertain. A major geopolitical conflict, accelerating inflation or a recession in the United States, rising deficits in several countries – these are the risks most likely to reverse the trend, according to several brokers. Just like the US presidential election, with its change in economic policy and its uncertainties. Volatility is likely to persist.
The starting point, the spike in inflation seen on both sides of the Atlantic, confirmed by a moderation in the pace of price rises, triggered renewed appetite directly linked to the prospects of monetary easing by the US Federal Reserve. This favourable environment for investors has resulted in a rush to the bond market. Their wish was to continue to benefit from the still comfortable yields offered by government bonds, before they were mechanically reduced by the Fed’s rate cut. Under the effects of massive buying, yields eased sharply until a Trafalgar coup at the end of the summer, and the bulls lost their grip.
Warmed by the heat of the summer and continuing favourable economic data, the yield on the yield on 10-year US Treasury debt ended up melting (too) quickly, dropping from 4.7% to 3.6% between May and mid-September. Then, boom! The FED’s jumbo rate cut of 0.5% on 18 September caused a surprising backlash. Then, at , the bond market had to rethink its approach and take on board the possibility of a slower easing, with the US economy still buoyant and showing too few weaknesses, explain Guillaume Fradin, manager of the LBPAM ISR Absolute Return Credit fund, and Jean-Marc Frelet, manager of DNCA Invest Credit Conviction.
The market has also read the electoral expectations that spice up monetary and technical considerations. And the elections have reawakened the Trump Trade, with customs and tax decisions that are likely to boost inflation and increase the deficit, according to Guillaume Fradin and Jean-Marc Frelet.
As a result, the yield on 10-year Treasury debt has risen from its summer low to 4.45% at the beginning of November. In October, the bond market recorded its worst month since 2022, with yields rising by 0.5% across most maturities. We should also add that the markets fear that the Fed will not cut rates as much as expected (six rate cuts were anticipated at the start of the year). The better-than-expected economic and employment figures for September and October could prompt the Federal Reserve to scale back its rate cuts, or even put them on hold. This causes obligations to waver,” explains Guillaume Fradin.
In this yo-yo game, some bond managers had to pull their hair out. With August’s fragile employment figures, Guillaume Fradin took the opportunity to unwind his positions, notably in German 5- and 10-year futures, increasing his cash position by taking advantage of the fall in yields and reinvesting in shorter maturities. As a result, the portfolio’s sensitivity to the market was logically reduced with the reduction in exposure to long maturities and was better able to cushion the change in market direction.
United States: good, euro zone: not so good.
Macroeconomics plays an important role in these movements. And there are signs that things are going well in the United States and much less well in Europe, although not catastrophically.
Guillaume Fradin has 22 years’ experience and has been at the helm of the LBP AM SRI Absolute Return fund since 2020. His aim is to maximise performance by limiting downside in his playground of euro, sterling and dollar-denominated bonds. Risk in the bond market can have several faces, such as interest-rate risk, but also spread risk (the difference in yield between different qualities of bonds), i.e. the loss of a company’s (or a country’s) financial strength, which will logically require investors to pay higher yield premiums in order to accept the increased risk.
For Jean-Marc Frelet, the problem of debt and deficits hangs over the markets like a sword of Damocles. Indeed, the old continent offers a slightly different profile. And the manager highlights the history of productivity: “While productivity in the eurozone was 95% of the US level a few years ago, it has now fallen to 80%. It’s a real problem A harsh reminder of the sad economic reality. With stronger economic growth making it easier to control a deficit, the United States is continuing to outperform Europe, while the eurozone is plunging into a slow economic stall with sluggish growth. And there are other dangers lurking, such as the ageing of the population, and Germany, the eurozone’s legendary leading economy, is in a slump and struggling to produce solid economic figures. The latest figures just managed to dodge a recession, while France, whose leading economic partner is Germany, has discovered an abysmal deficit. And the economic indicators are not encouraging us to be overly optimistic. However, Italy and Spain, as well as Greece, are the pleasant surprises, offsetting this pessimism in the eurozone to some extent. Nevertheless, the IMF is forecasting a return to growth in Europe in 2025, while the United States, whose growth has remained resilient until now, will experience a moderate slowdown. In short, an atmosphere that should provide more bargains in the credit market for two-way funds.
The backbone of our macroeconomic scenario can be summed up in one word: “caution in the short term”. With a little too much optimism about inflation and interest rate expectations in Europe, everything could be turned on its head,” adds Guillaume Fradin.
Two funds..
LBPAM ISR Absolute Return Crédit is distinguished by the use of eight different strategies, calibrated and chosen according to the different market cycles to optimise the risk/return ratio, while being flexible and aiming to reduce volatility, with an Investment Grade mid-quality portfolio with room for manoeuvre in High Yield and the ability to seize international opportunities.
However, in 2023, the fund was able to ride the wave of falling interest rates and yields to its advantage, reaping a capital gain of more than 8.49%. And 2024 is also off to a good start, with a performance approaching 7% despite the sharp rise in yields. And apart from the difficult year of 2022, which ended with a loss of 3.43% (quickly erased the following year with a gain of 8.49%), annual returns have tended to hover around 3% since 2019 (5-year annualised return : 3,03 %).
Finally, DNCA Invest Credit Conviction invests in a GI portfolio with room for manoeuvre in the High Yield universe. “We remain confident in the credit market, which should benefit from potential future rate cuts and positive, albeit below-average, economic growth. For this reason, we always give preference to portage. Our duration is around 3 years. The fund also has a responsible performance of 4.92,” says the management team. Since1 January, the fund has returned 7.21%, almost twice as much as its benchmark Bloomberg Euro Aggregate Corporate Index (+3.93% at 7 November).
It is important to note that the management team arriving in June 2023 from AXA IM is not making its first attempt. Ismaël Lecanu and Jean-Marc Frelet have been co-managing a credit strategy since 2015, which they recently re-implemented at DNCA. This strategy stands out for its unconstrained volatility management, with a rebound capacity 2 to 3 times greater than that of its Morningstar category and its benchmark index, while maintaining a similar maximum drawdown.
In addition, after the correction linked to the Covid crisis, the fund managed to recover in just over 200 days, while the index and the category average are still struggling to return to their initial levels.
In October 2024, the fund reached significant assets under management of over €500 million, confirming investor confidence in the team’s proactive and opportunistic approach in just over a year.
