Issued in June 2016
For Professional Investors and Advisers Only
Monthly Newsletter
Schroder ISF* EURO Corporate Bond
Covering May 2016
Performance %**
May
2016
1 year
3 years
(p.a.)
5 years
(p.a.)
Schroder ISF EURO
Corporate Bond (A Acc
shares)
0.2
2.4
4.7
4.9
Schroder ISF EURO
Corporate Bond (I shares)
0.2
3.4
5.8
6.0
Bank of America Merrill Lynch
EMU Corporate Index
0.3
2.1
3.8
5.2
**A & I Share performance net of fees, NAV to NAV (bid to bid).
Source: Schroders, as at 31/05/16, EUR returns
Market overview
In May, the European Central Bank’s (ECB)
approaching entrance into euro credit markets was
ultimately overshadowed by a number of other
global factors. Macroeconomic data for the
eurozone remained broadly positive, as did the
latest updates from the US. However, the stability
in economic activity was balanced by reminders
from the Federal Reserve (Fed) that it is likely to
unsettle markets with further rate hikes this year.
China’s deterioration also continued and the
outcome of the UK’s referendum vote remains
highly uncertain. Euro credit spreads widened in
spite of the continued technical tail-wind from the
ECB.
The May reading of eurozone manufacturing
activity - as measured by the purchasing managers
index (PMI) - indicated a slight drop of 0.2 points to
51.5. The figure was bolstered by stronger activity
in Germany, while numbers from Italy and Spain
weakened. The service sector meanwhile
continues to support business activity on
aggregate; the PMI services number for May
improving from 53.1 to 53.3. The composite PMI
reading for the eurozone therefore rose from 53.0
to 53.1. Inflation remains fragile, but improved over
the month, rising from -0.2% to -0.1%. The
eurozone unemployment rate remained steady at
10.2% - as expected - in April. This is the lowest
reading since Aug 2011 and reflects ongoing
improvement.
In the short term, economic data beyond the
eurozone was perhaps more impactful to credit
markets. Q1 GDP growth for the US was revised
upwards in May, from 0.5% to 0.8% (quarter-onquarter annualised). The latest payroll number was
much weaker on a relative basis that April, but the
fundamental strength of the US economy
prompted the Fed to reiterate in May that the next
rate rise should be expected in “coming months”.
Adding to the Fed’s potentially destabilising rate
hike, the fragility of China’s economy was restated
through May, while the UK’s membership of the
EU remains uncertain in the lead up the
referendum.
The BofA Merrill Lynch Euro Corporate index
generated total returns of 0.3% in May but
underperformed government bonds by -0.2%. The
equivalent high yield index gained 0.1% in total
returns but generated excess returns of -0.2%. The
strongest sectors in the month were banking and
capital goods, while insurance and healthcare
struggled.
Primary markets were active once again in May,
with gross euro investment grade issuance of
€69.5 billion. This is the busiest May for new
issues since 2009. In light of the ECB’s activity it is
perhaps no surprise that non-financials led the
activity, with a large portion of new bonds biased
towards terms of over 10 years. Sterling issuance
remains very low. A (gross) total of £1.2 billion in
new sterling bonds was issued in May.
Portfolio overview
The portfolio generated positive returns in May;
outperforming in gross terms but underperforming
the benchmark when adjusted for fees.
The performance was attributable to a combination
of the carry generated by the underlying bond
portfolio and credit selection.
The underweight in financials, as well as our
exposure to off benchmark sterling and dollar
denominated names was a positive stance for the
strategy in May.
We remain underweight financials – excluding
REITS – overall and further reduced exposure
during the month, rotating the capital into nonfinancials where we see better risk adjusted return
potential. The additions were largely in industrial
names, and diversified across healthcare, autos,
* Schroder International Selection Fund is referred to as Schroder ISF throughout this document
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Issued in June 2016
energy and basic materials. The investment team’s
approach is not particularly moved by the ECB’s
corporate bond activity and we have been biased
towards non-financial assets for some time. We
also took the opportunity to modestly increase high
yield exposure in May to selected issuers.
The portfolio’s key overweights at the end of the
month were in real estate, media, healthcare and
telecoms. As with the core euro exposures, off
benchmark exposure in sterling names is biased
toward non-financial names and diversified across
a range of sub-sectors. In US dollar holdings, the
bias towards non-financials is consistent, with the
telecoms, utilities and energy sectors favoured.
Outlook and strategy
From a macroeconomic perspective our view for
euro corporate bonds has grown more neutral.
There has been a continued, modest improvement
in data - most obviously in the US but throughout
the majority of the world’s major developed
markets - for a number of months. Despite this, we
feel that the tailwinds for developed market growth
may be fading.
The weakness in the oil price from the middle of
last year took some time to show as a boost for
growth. Now this delayed, positive effect is
beginning to wane. China, which had also been
showing some signs of stabilisation, has continued
to decelerate and we expect this to become more
noticeable as a headwind for global demand in late
2016. In the eurozone, economic fundamentals
remain relatively resilient, but we are cognisant
that growth may begin to cool. In the UK, it is
difficult to detangle the already moderating data
from “Brexit” uncertainty, which is causing some
trepidation in industrial activity. Although the
service sector continues to be more resilient, the
weaker sterling hasn't helped manufacturing.
This more cautious view of the macroeconomic
back drop does not alter our appraisal of euro
credit from a corporate fundamentals perspective.
European corporates are still exhibiting prudence
in their balance sheet management. In spite of the
low cost of refinancing, releveraging has not yet
risen to levels we consider to be dangerous. Unlike
the US, merger activity has not seen a widespread
increase. Similarly, in the UK the absolute level of
insolvencies remains very low and may be
perpetuating an environment in which non-viable
companies remain active. Overall though, we
remain modestly positive about sterling investment
grade credit fundamentals relative to the US.
From a technical perspective, the level of issuance
in euro credit markets has picked up markedly
since the announcement of the ECB’s corporate
sector buying activity, while fund flows into euro
mutual funds have cooled. Nonetheless, the
tailwind remains strong for euro credit markets.
Investment grade bonds are a more direct
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For Professional Investors and Advisers Only
beneficiary but we expect high yield bonds to see a
trickle-down effect that will also support spreads.
On balance, while we are not deterred by this
environment, we feel that elevated valuations in
euro investment grade bonds combined with
mounting headwinds for the global economy
provide a neutral view for the asset class. In terms
of off benchmark exposure, we take a similarly
neutral view of sterling and US dollar investment
grade debt. In the UK, the support from limited
issuance is balanced by the unknowable outcome
of the EU referendum. In the US, we have fewer
economic doubts, but political uncertainty is rife
and high leverage more prevalent. Finally, in euro
high yield bonds, yield-motivated investors have
buoyed the sector in recent weeks and squeezed
more of the value out of the market. Here too, we
are growing more cautious.
Issued in June 2016
For Professional Investors and Advisers Only
Monthly Newsletter
Schroder ISF EURO Corporate Bond
Fund data as at 31 May 2016
Team
Lead portfolio manager(s)
Patrick Vogel
Size and Holdings
Fund size in base currency
Number of issuers*
€7.8 billion
284
CDS Summary
Total Single Name Shorts
Total Single Name Longs
Total Index Shorts
Total Index Longs
Total Swaption Shorts
Total Swaption Longs
Total Net Synthetic exposure
Total Cash Bonds
%
-9.2
7.5
-0.7
-2.4
97.6
Source: Schroders
*Fund issuer number treats each CDS index as a single issuer
and excludes the non-credit line items (Futures Fixed Income,
Margin Cash Balance, SYN, Synthetic Cash Fixed Income,
Currency).
Portfolio Statistics
Effective Duration
Effective Yield (%)
Average OAS*
Average credit rating
Fund vs. Index
5.3
1.7
191.1
BBB+
5.2
1.0
126.4
A-
*Option Adjusted Spread
Credit Quality*
AAA
AA
A
BBB
BB
B
Unrated
Cash and money markets
Portfolio (%)
1.9
3.3
21.4
55.0
10.6
1.0
3.3
1.7
Index (%)
0.4
12.3
42.8
44.3
0.2
0.0
*Ratings by average of S&P, Moody’s and Fitch.
Note: The chart will not add up to 100 as it does not include
futures, IRS, forwards, TRS, cash synthetic or the CDS float
(non-active leg of the CDS).
Currency Allocation*
%
CHF
0.00
EUR
99.97
GBP
0.02
USD
0.01
*Portfolio hedged to base currency
Sector Allocation
Sovereign/Quasi Sovereign
Senior Financials
Subordinated Financials
Collateralized
Industrials
Utility
Cash and Money Markets
CDS Basket
Memo: High Yield*
Portfolio (%)
Index (%)
6.7
18.5
11.9
2.8
46.1
10.9
1.7
-0.7
11.6
2.9
29.1
9.4
0.0
46.3
12.1
0.0
0.0
0.0
*High yield bonds are also included in the other sector
breakdown in the rest of the chart. Total will not equal 100%
Note: The chart will not add up to 100 as it does not include
futures, IRS, forwards, TRS, cash synthetic or the CDS float
(non-active leg of the CDS).
Important Information. This document does not constitute an offer to anyone, or a solicitation by anyone, to subscribe for shares of Schroder International
Selection Fund (the “Company”). Nothing in this document should be construed as advice and is therefore not a recommendation to buy or sell shares.
Subscriptions for shares of the Company can only be made on the basis of its latest Key Investor Information Document and prospectus, together with the
latest audited annual report (and subsequent unaudited semi-annual report, if published), copies of which can be obtained, free of charge, from Schroder
Investment Management (Luxembourg) S.A. An investment in the Company entails risks, which are fully described in the prospectus. Past performance is
not a reliable indicator of future results, prices of shares and the income from them may fall as well as rise and investors may not get the amount
originally invested. Schroders has expressed its own views and opinions in this document and these may change. This document is issued by Schroder
Investment Management Ltd., 31, Gresham Street, EC2V 7QA, who is authorised and regulated by the Financial Conduct Authority. For your security,
communications may be taped or monitored. Risk Considerations. The capital is not guaranteed. Non-investment grade securities will generally pay higher
yields than more highly rated securities but will be subject to greater market, credit and default risk. A security issuer may not be able to meet its obligations to
make timely payments of interest and principal. This will affect the credit rating of those securities. Currency derivative instruments are subject to the default
risk of the counterparty. The unrealised gain and some of the desired market exposure may be lost. Investments denominated in a currency other than that of
the share-class may not be hedged. The market movements between those currencies will impact the share-class. Investment in bonds and other debt
instruments including related derivatives is subject to interest rate risk. The value of the fund may go down if interest rate rise and vice versa. It may be
difficult to sell quickly positions of one or more companies to meet redemption requests upon demand in extreme market conditions. The Fund may hold
indirect short exposure in anticipation of a decline of prices of these exposures or increase of interest rate. The Fund may be leveraged, which may increase
its volatility.
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