Brief comments from Catellas fixed-income team

There are several reasons for the market turbulence. It's a case of pick and choose

- Lower growth in China, and the country's decreased foreign exchange reserves – causing concern in world financial markets

- Low oil prices could result in bankruptcies in the energy sector globally

- Weaker than expected profitability for companies that have reported at the start of the year

- Deterioration of macroeconomic statistics in the US, although unemployment data seem okay

- Weak balance sheets for some of Europe's banks

- High covariance between commodity prices and the risk appetite of investors

Development of key assets since the beginning of the year that affect the value of holdings in corporate bonds (from the start of the year until February 9, 2016):

The price of oil has dropped by about 2o per cent

Nordic equities (VINX) are down 15 per cent

Nordic high-yield bonds are down about 3 per cent

Junior bank bonds (CoCos) are down 7-10 per cent

One clear proof of reduced risk appetite among investors is that flows into safe assets have led to:

Swedish ten-year market interest rate has halved since the beginning of the year. It was 1 per cent at the start of the year and is now just below 0.5 per cent.
The yield on a five-year government bond is negative for the first time.

What has happened to credit spreads in early 2016?

In Europe, the funding cost of senior bank bonds has risen, moving from 0.75 percent to 1.35 percent since the start of the year. We have seen the same movements in investment grade companies. Weaker balance sheets in European banks are evidenced by Italian and Portuguese banks, which lead the field for which spreads have widened most.

As the icing on the cake, we have doubts about some European banks' capital adequacy and their ability to pay coupons to their creditors. One such example is Deutsche Bank, and concerns have arisen in the market over its junior loans (known as CoCos), which are trading down sharply. Deutsche Bank's debt has traded down 25 percent since the start of the year, and these worries are also infecting the CoCos of other banks.
This naturally also impacts Swedish banks, with AT1 bonds (CoCos) dropping sharply in value due to widening spreads. For example, Handelsbanken's junior loans (BBB) currently yield 7.5 per cent. This is despite Swedish banks being among Europe's most well capitalised, and coupon risk (failure to pay coupons) must be regarded as minimal.

Unlike the equities market, the fixed income market has securities that mature for payment, provided the company does not go bankrupt. We feel that price movements in many holdings in the bond market are exaggerated. In Sweden, no new high-yield loans are currently being issued .

What will have to happen for the value of corporate bonds to rise going forward?

The last thing the ECB wants to see is a European financial crisis flaring up. Addressing this requires a larger and more extensive buy-back programme by the ECB. As we have seen in previous downturns, action is required from central banks to instil courage into risk appetite and to improve liquidity in the market. At the last ECB meeting, Draghi once again announced that the bank is willing to do "whatever it takes", and that the current stimulus programme is under scrutiny.

Outlook for 2016

With negative interest rates, traditional savings that pay interest have played out their role. What we are seeing in the corporate bond market is more about flow and liquidity, rather than a marked increase in corporate risk. Bankruptcy risk in investment grade credit is still low, which makes us think that current spreads on better companies offer an attractive risk/reward profile.

As for high yield and the junior bank bonds (CoCos), only a small number of bonds are now trading at or above their issue price, and at the price that should be repaid. This suggests that there is an upside for investors that are selective, do their research and are in for the longer term.

Brief facts about Catella´s three fixed income funds:

Avkastningsfond

Running yield 2.0 per cent
Duration: 0.9 years
Diversification: 90 holdings (no holding larger than 3 per cent)

Nordic Corporate Bond Flex

Running yield 5.9 per cent 
Duration 1.7 per cent
Diversification: 70 holdings (no holding larger than 3 per cent)

Credit Opportunity

Running yield 7.1 per cent
Duration 2.4 per cent
Diversification: 38 holdings (no holding larger than 3per cent)

Glossary:
Investment grade: Corporate bonds with low credit risk (Rating: AAA to BBB)
High yield: Corporate bonds with high credit risk (Rating: BB to C)
Credit spreads: The difference in interest rates between the different levels of risk in the corporate bond market, often based on the risk-free rate (government treasury bills).

Important information:
Investments in fund units are associated with risk. Past performance is no guarantee of future returns. The money invested in a fund can increase and decrease in value and it is not certain that you will get back the full amount invested. No consideration is given to inflation. The Catella Balanserad, Catella Credit Opportunity, Catella Fokus and Catella Hedgefond funds are special funds under the Swedish Alternative Investment Fund Managers Act (SFS 2013:561) (AIFM). Catella Reavinstfond and Catella Småbolagsfond may use derivatives, and the value of the funds may vary significantly over time. The value of Catella Sverige Index may vary significantly over time. Catella Avkastningsfond may use derivatives and may have a larger proportion of the fund invested in bonds and other debt instruments issued by individual national and local authorities and within the EEA than other mutual funds, in accordance with Chapter 5, Article 8 of the Swedish Investment Funds Act (SFS 2004:46). Catella Nordic Long Short Equity and Catella Nordic Corporate Bond Flex may use derivatives and may have a greater proportion of the funds invested in bonds and other debt instruments issued by individual national and local authorities and within the EEA than other mutual funds. For more details, complete prospectuses, key investor information, and annual and half-yearly reports, please refer to our website at catella.se/fonder or phone +46 8 614 25 00.