February 2020

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  • 1. Client is asking a view on the new issued AT1 cocos and if we participated in any of the new deals or not

    Context: Low back end AT1 cocos bears a higher extension risk than high back end one

    Impact for the fund: Positive as we are not taking exposure to bonds bearing a high extension risk

    View on most recent AT1 cocos (“newer vintage”): not for us and not now – especially not at current prices. The combination of low spread at issuance (so-called back-end) and longer call dates makes this new vintage highly convex i.e. in a weak market, price of these could easily drop more than 10 points should investors start to reprice these AT1 cocos from next-call-date to maturity as we have experienced during 2018.

    Just to give an example, the most recent 4.5% BNP Perp was issued with a spread of 294bps. On the risk off sentiment created by the Covid-19, Spreads on AT1 cocos already widened to almost 440bps (+140bps) and for this particular bond at the current level of 400bps. This means that for bonds such as the 4.5% BNP Perp which is currently trading on a next call date basis, should investors reprice it on a YTM basis, and for the same level of spread, price of the bond should drop from 94 to 84.

    On the same assumption we have not participated in some of the new issuance of AT1 cocos like the 5.1% CS Perp issued in January this year, the 4.875% ING Perp and the 3.875 UCGIM Perp both issued end of Feb this year.

     

  • 2. Client is asking what has been issued in the RT1 space and on what name we have been investing/added lately?

    Context: New RT1 bonds have been issued in the market and this securities offer very attractive yields holding less risk than AT1 Cocos issued by banks

    Impact for the fund: An attractive asset class where the Credit Opps is one of the few peers invested

    In a nutshell:

    • RT1s are new-style subordinated bonds issued by insurance companies under the Solvency II regulatory framework
    • Similar structure to bank AT1 CoCo (junior subordinated, non-cumulative coupons, write-down/conversion of solvency falls below a certain level)
    • Nevertheless, RT1s are less risky for investors as (1) compared to AT1 CoCos, coupon risk is much lower as coupons are only cancelled if minimum Solvency requirements are breached (no MDA level like for banks), and (2) there is no bail-in framework for insurers, which limits the tail risk of bonds written down to zero like we have seen with Banco Popular.
    • Valuations on Insurance RT1s offer more than 100bps spread pick-up compared to AT1 CoCos despite a better structure for bondholders and extremely solid fundamentals. Therefore, very constructive top-down view on the product.

    In terms of latest names added:

    • Ageas 3.875% RT1, perpetual callable in 2029, issued in December 2019. Yield of close to 4% in EUR (equivalent to c6%+ in $) and spreads of close to 400bps, highly attractive for a high quality issuer and BBB-rated bond.
    • Ageas, the leading Belgian insurer, with a Solvency ratio of 199% as of 3Q19 (or €4bn excess capital), strong operating performance with a c11% return on equity (strong ability to generate capital organically). Strong fundamentals and therefore positive view on the issuer.
    • Bond has returned more than 7% since it was issued, remains very attractive

     

    For our a detailed insight into Insurance RT1s, please see our article (https://www.gam.com/fr/our-thinking/investment-opinions/a-guide-to-the-rt1-market).

  • 3. We have been asked why the performances of the fund are trailing to the Bloomberg Barclays AT1 CoCo Index

    Context: The EUR fund has been performing differently than the USD fund when compared to the Bloomberg Barclays AT1 CoCo indexes EUR and USD respectively

    The difference in performance between the EUR fund and USD fund when compared to the AT1 coco EUR and USD indexes respectively are mainly due to the higher proportion of high beta names in the EUR AT1 CoCo Index. While the USD AT1 CoCo index is dominated by the higher quality names that we hold like HSBC, UBS, CS, etc (and therefore is a closer proxy of the AT1s we hold in the USD Fund), over the past few years we have seen more lower quality/higher beta issuance in EUR AT1 CoCos. In particular this has been either smaller names or peripheral names (Italy/Spain), of which we have obviously stayed away from given the weaker fundamentals (15% of the index is now Italy and 28% Spain). Nevertheless, as sentiment has been very strong, these names have outperformed the higher quality names. For example, see the chart below comparing the performance of a few second-tier peripheral names (Banco BPM, an Italian bank or Bankia a Spanish Bank) against Rabobank or HSBC. As these weaker names in the Periphery are more exposed to idiosyncratic events as well as political issues (Italy for example) – this can lead to very poor outcomes for bondholders (Banco Popular for example) as well as very high volatility (see the chart of Monte dei Paschi’s Tier 2 falling to 45% in early 2019).

     

     

  • 4. We have been asked what the impact of the Covid-19 virus on the Credit Opportunities Fund is

    Context: Considering the risk-off created by the headlines on the corona virus this remains a non credit event for the GAM Star Credit Opportunities

    Impact for the fund: non credit event

    Impact of Covid-19 on our funds: from a credit standpoint and given current information – credit neutral. Our base case remains that economy weakness arising from the virus should be temporary and front-loaded. In the meantime, this will force central banks to remain highly accommodative, with a side-effect of a strong search for yield. as indicated by negative yielding debt at USD 14tr or an increase of 3tr YTD. Obviously, coronavirus is not neutral in terms of earnings growth as well as a potential disruptor of supply chain (bad news for certain sectors/corporates, HY, etc.), but once again, we expect this to be temporary. Furthermore, we expect sub-debt from financials to be somewhat immune given the combination of high steady income, strong fundamentals, supportive technical and last but not least appealing relative value.

    View of recent sell-off/reason for the slight correction: while we expect impact of Covid-19 to be credit neutral for issuers held in the fund, price of the bonds held in the fund have not been completely immune by the sharp sell-off that took place in other markets this week (for example, EU equity that dropped double digit this week) and on average price of bonds held in the fund have decline on average between 2-2.5%. We feel that this price weakness should be short lived and would expect price to quickly recover. Furthermore, we are not changing our base case of +8 for the EUR fund and +9% for the USD/GBP fund – especially given the high level of income that the funds are capturing.

     

    In addition, concerning the pandemic risk from a credit standpoint, the reinsurers sector is the one that could potentially be mostly impacted.

    For this reason, looking through the disclosures of Reinsurers, expectations for the impact of the Coronavirus to be very manageable. An example could be Swiss Re which discloses explicitly the impact of pandemics modelled in their capital planning (1/200 year event VaR type).

    Below is from Swiss Re’s FY17 disclosures (similar as of FY18) where the impact on STT of 1 in 200 years pandemic event would have a c16pp impact on the group’s Solvency – which currently stands at 251%, or a large $24bn excess to requirements (Swiss SST basis). In monetary terms the group models a $2.8bn loss from a 1/200y lethal pandemic event.

     

     

    Secondly, Scor reports that in their Solvency II capital planning they use a 1/200-year pandemic scenario with >10 millions death in the general population compared to close to 3k currently. Scor had a SII ratio of 226%, well in excess of the 100% requirement, or €6bn.

    Even when looking at the most exposed sector for the impact of the Covid-19 this event remains extremely manageable from a credit prospective

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