Carmignac Sécurité : Letter from the Fund Manager

Financial markets became a good deal harder to fathom in the second quarter of the year. Expectations for a vigorous global economic upswing – buoyed by the prospect of economic re-opening as vaccination campaigns gained traction and central banks let inflation overshoot their targets – had driven interest rates up in the first quarter. But that trend had reversed by late March in the United States and mid-May in the eurozone.

There were several factors behind that reversal. For starters, US employment data came in well below economists’ forecasts, while US and Chinese inflation surprised to the upside. In addition, the less dovish stance adopted by the Federal Reserve (Fed) caught the investment community on the back foot, which accentuated the yield-curve flattening under way. Financial-market participants brought forward their rate-hike expectations (with 2-year Treasury yields gaining 8 basis points during the quarter), and now fear the Fed may get monetary policy wrong, resulting in a sharp slowdown in economic growth (which explains why 30-year yields dropped by 33 basis points over the same period). And though realised inflation has climbed significantly, investors don’t believe the trend will continue. They attribute the current bout of inflation to a combination of catch-up from last-year and supply bottlenecks in a recovery that has taken off too fast. The most striking example of these bottlenecks is the semiconductor shortage, which has hamstrung the auto industry. Europe’s fixed-income markets have channelled those in the US, though with a lag and to a more limited extent. The rise in German bond yields during the first part of the quarter wasn’t wiped out after all. The 10-year yield ended the period up 10 basis points at –0.21%¹.

One might have expected such an unintelligible state of play to increase market volatility – usually bad news for credit investors. Except it didn’t. Volatility has stayed very low, and thus supported carry strategies, including in corporate bonds. In the euro market, credit spreads for investment-grade issuers tightened by an average of 7 to 8 basis points, with the result that this asset class added capital gains to gains from the carry trade. The more speculative corner of the market did even better during the quarter, with spreads narrowing by some 20 basis points and the European high-yield bond index climbing about 1.45%.

We substantially reshuffled the Carmignac Sécurité portfolio during the second quarter.

• First, we upped our exposure to corporate credit in continuity with the approach we initiated at the end of the first quarter of 2021. Rising yields since the beginning of the year enabled us to hunt down absolute yields offering attractive carry opportunities.
  
• Second, we re-introduced Italian government paper into our portfolio starting in mid-May. At the end of the quarter, the modified duration of our Italian holdings, spanning government and corporate bonds, stood at roughly 1.
  
• Our exposure to CLOs (Collateralised Loan Obligations) likewise increased – a first in several quarters. The primary market offered attractive opportunities in top-rated tranches that moved us to raise that exposure by more than 1 percentage point to about 7.5% of the portfolio.
  

Our portfolio is thus made up of long positions in assets offering good spreads (chiefly corporate credit and Italian bonds), where the interest-rate risk is hedged in part by short positions in British and American sovereigns and by swaps. Even if interest rates were to head back upwards, the increase wouldn’t be large enough to put pressure on risk assets. We believe the major central banks will avoid undermining the economic recovery by acting too fast and/or too vigorously as they did in late 2018. Late-cycle phases (and we’re likely nearing the end of a cycle of extreme monetary-policy easing) are often accompanied by financial-market volatility. That will call for even greater flexibility in how we at Carmignac Sécurité manage our portfolio in the months to come.