Risk appetite falls on growth concerns

Turbulence in the debt market

The period from January until April was rather undramatic. Then from May until June, we saw both a sharp rise in market interest rates (a medium-term bond index with government and mortgage bonds dropped 1.5 percent during the same period), while the risk premium on corporate bonds and mortgage bonds rose markedly. The underlying factors were mainly to be found in the Greek crisis and expectations that the US central bank would start to raise interest rates. From the relative calm in July, volatility then increased dramatically again during August as worries intensified about growth of the Chinese economy. In September, concerns about the performance of the global economy have accelerated, resulting in an increased risk premium on corporate bonds. Furthermore, a number of specific company and sector events have fuelled the turmoil in the debt markets. The Norwegian corporate bond market has been hit hard by lower oil prices, with sharply falling prices for companies that mainly operate in offshore drilling and oil services. Vattenfall, whose hybrid bond was downgraded to junk status, and other energy companies in Europe may be too low in their provisions as a result of Germany decommissioning its nuclear power. Volkswagen really hit the rocks due to suspected manipulation of emission controls, and this also spilled over into Volvo and other car and truck manufacturers. Even hybrid debt issued by banks has been sold off fairly indiscriminately.

On top of this, the market is suffering from poor liquidity as a result new capital adequacy rules placed on banks, which have resulted in increased liquidity premiums in the corporate bond market. The rules make it relatively costly for intermediaries, such as banks, to hold inventory and to provide liquidity. This means that, in principle, it is only end clients, such as debt funds and institutions that are buying and selling, without any buffer in between. The fact that a seller must always identify a buyer is, in some cases, resulting in large adjustments in price without any change in the credit risk of the underlying companies. On the whole, the corporate bond market has become more driven by liquidity and flows, which in turn has increased the volatility, particularly for high yield bonds but also, to some extent, for investment grade bonds.

Opportunity and risk in today's debt market

Our assessment is that the return on traditional interest-based savings will be low, if not non-existent, in the coming 12-18 months. We base this on the Swedish Riksbank's very clear inflation target of 2 percent. Considering that inflation and inflation expectations are below the Riksbank's target, the current repo rate of -0.35 percent could very well be reduced slightly further by year-end. Traditional fixed-income funds are also unlikely to gain any significant positive contribution from falling market interest rates, since these are already at extremely low levels. Treasury bills at -0.5 percent, and a 5-year government bond yielding 0 percent in expected annual return, further underline the extreme circumstances in the fixed-income market today.

However, there are some interesting opportunities in the corporate bond market for those who are willing to accept higher risk and thus enhance their expected return. As the prices of corporate bonds have fallen, so the expected return on the corporate bond market has risen. If we look back at history, earlier slumps in the debt market associated with the Lehman crisis in 2008-2009 and the European financial crisis in autumn 2011 have offered attractive levels at which to buy into the debt market. The timing with regard to entering the corporate bond market is difficult, if not impossible, to call today. So the best thing may be to buy in over a period in order to reduce the timing risk, and to have a relatively long investment horizon.

For those who prefer to invest in funds, with the diversification, daily liquidity and active management of capital that these can provide, we are able to offer the following alternatives for fixed-income funds at Catella.

* The running yield can be seen as a possible estimate of the fund's performance over the coming 12 months, before charges. This estimate is based on the running yield in the fund and does not take into account changes in interest rates and changes in the risk premium on corporate bonds, which means that the outcome may differ both positively or negatively.
**31 August 2015 *** 29 September 2015

The risks of investing in the corporate bond market, as we currently see it, are mainly the following:

•  Deterioration in the economic situation as a result of weaker growth in China, which is likely in turn to raise the risk premium on corporate bonds (falling prices) as bankruptcies would be expected to increase.
•  Continued weak commodity prices, especially oil, which would delay the recovery in the Norwegian economy.
•  Policy mistakes by the Fed; if the Fed were to raise interest rates too quickly and by too much, the US economy could tighten.

 Deterioration of liquidity.

Our interest assessment/strategy today for 6-12 months forward:

•  Low or lower repo rate well into 2016.
•  Unchanged or higher market interest rates => steeper yield curve.
•  Stable or slightly higher prices on corporate bonds with a high credit rating.
•  More volatile prices on corporate bonds with a low credit rating.

  IMPORTANT INFORMATION
  Past performance is no guarantee of future returns. The money invested in a fund can increase and decrease in value and there is no guarantee that you will get back the full amount invested. No consideration is given to inflation. The Catella Avkastningsfond fund may use derivatives and may have a larger proportion of its assets invested in bonds and other debt instruments issued by individual Swedish mortgage institutions or governments and municipal governments and in the EEA than other investment funds. Catella Corporate Bond Flex may use derivatives and may have a larger proportion of its assets invested in bonds and other debt instruments issued by individual governments and municipal governments and in the EEA than other investment funds. Catella Credit Opportunity is a special fund as defined in the Alternative Investment Fund Managers Act (SFS 2013:561) (AIFM). If you wish to read the full prospectus or key investor information document, or view annual or interim reports for the fund, please contact us using the details below.