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We have been asked our view on current market situation in regard to the Credit Opps and the subordinated debt market

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  • Mid-March 2020
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  • We have been asked our view on current market situation in regard to the Credit Opps and the subordinated debt market

Context: Considering the risk-off created by the incertitude and headlines on the covid-19, this remains a non-credit event for the GAM Star Credit Opport

Impact for the fund: Temporary risk off / non-credit event

Credit strength remains strong  for  our issuers,  and while the current crisis will affect profits across the economy we view the impact of the coronavirus as having a minimal impact on credit quality for our holdings and our base case remains that economic weakness arising from the virus should be temporary.

By “non-credit event”, what we mean and especially looking at the banks is that the potential increase in NPLs, cost of risk, etc due to covid-19 should have no impact on the credit quality of issuers held in the fund as base on current information and backed by stress-tests conducted by regulators, it can be organically absorbed by pre-provision income as well as the excess regulatory capital if needed.

With our focus on balance sheets rather than earnings , the financial sector has  been forced by regulators to stress test  against scenarios far worse than the financial crisis and the result of stress tests conducted from the ECB and more recently from the Bank of England revealed that the financial sector is robust and capable of withstanding severe stress and rock solid capital levels have increased the overall resilience of the system. Furthermore, the stress tests did not include government or central bank support, which we have seen this week.

 

For this reason, while not being complacent and being very selective on which companies we hold,  we remain very constructive on the funds’ ability to both capture the high and steady income  and for our companies to ride out the downturn in economic activity with credit intact as well as benefit from price appreciation from this point.

We continue to be well positioned in mainly national champions – with no exposure to Italian banks.

Valuations:

Current spreads on AT1 are above 550 vs 300 in Jan20 and our credit view remaining resilient on the underlying issuers that have just seen an improvement in their capital strength arising from the multi-year process of capital strengthening imposed by the regulators. We note that current valuations, offer an extraordinary opportunity to capture a high steady income of more than 5.5% on a YTW basis from the strongest issuers of the financial sector, in an environment of negative rates where currently more than 14trillion are returning a negative yield.

Strong fundamentals:

We have reached the end of the earnings season and we continue to observe strong operating performances and rock-solid balance sheets.

Overall the tier 1 common capital (CET1) ratios of banks increased, while non-performing loans (NPLs) continue to decrease showing the strength of the overall financial sector and the results achieved by the multi-year process of capital strengthening put in place by the regulator. For insurers, we have also seen strong solvency ratios while we anticipate weaker earnings for the next few quarters, as mentioned above, balance sheets are strong enough to ride out a very severe economic downturn

Outlook:

Unchanged, despite negative price movement due to the last days price drop from risk off situation arising from the panic on Covid-19, YTD the “EUR” fund has already accrued 0.85% from income

Bank earnings remain under pressure from low interest rates, negative headlines on Covid-19 and geopolitical uncertainty – which has resulted in an overall negative equity price reaction

From a credit perspective, despite a temporary pressure on prices, with larger buffers to protect bondholders and government action now being implemented, our credit view remains positive

We have managed this fund and its precursor fund through many crises, 9/11, 2008/9, European crises in 2011 and 2016, or travel shutdown after the Iceland Volcano in 2010. And in each case our emphasis on strong credit quality and the continuing capturing of income leads, after initial panic, to a pull to par and our fund recovering when the market reverts to pricing on fundamentals.

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