The search for yield continues, but it’s getting harder to find attractively priced bonds. Subordinated financials offer an attractive spread over corporate bonds and benefit from an improved fundamental outlook.
“Investment grade corporate bonds are priced for perfection,” says Jan Willem de Moor, fund manager of Robeco’s financial bonds strategy. “They are trading just below their long-term historical averages, but their underlying balance sheets are deteriorating, especially in the case of US corporates. European subordinated financial debt continues to offer value while the sector is still in deleveraging mode. Higher interest rates and the steeper yield curve will improve the profitability of banks and insurance companies. Stronger fundamentals, the influence of regulation, and compelling valuations will support long-term total returns.”
Subordinated financial bonds have performed well as investors have rediscovered the attractiveness of the financial sector in the current market. Since 2008, when banks were at the heart of the financial crisis, bond investors have shied away from investing in the financial sector, put off by the low capital buffers and rising number of non-performing loans. The low interest rate environment has been another concern, as this has negatively impacted the profitability of banks and insurance companies.
Since mid-2016, however, global bond yields have started to rise and European yield curves have steepened. “Pressure on the financial sector was relieved by the Bank of Japan’s announcement that it would not lower its short-term interest rate any further. And the Fed had already started to hike rates in December 2015. As of January 2018, the ECB will further reduce the size of its monthly bond purchases. Apart from these changes in central bank policy, the election of Donald Trump was another trigger for higher bond yields, as his plans to stimulate the US economy could push up growth and inflation,” explains De Moor.
In the summer of 2016, financial institution bonds started to outperform those of non-financial companies and their performance accelerated still further in 2017. “We expect this outperformance to continue,” says De Moor. “Regulations like Basel III and Solvency II have forced banks and insurers to reduce their leverage, scale down risky assets and improve liquidity. Their balance sheets are in much better shape than before the financial crisis. We foresee improved profitability for these companies in a climate where interest rates are no longer declining.”
“We are bullish on banks and insurance companies, but there are still specific issues for certain countries and companies,” states De Moor. “We have a very small exposure to Italian issuers as we are worried about political risk and the stagnant economy. Another area of concern is Portugal, where we have no investments. Scandinavian financials have strong credit fundamentals but are currently not attractive because of low spreads. We are enthusiastic about Spain, though developments surrounding Banco Popular have shown that credit selection remains very important. We did not have any exposure to this bank. Early September, the Catalonian independence issue caused volatility, but as we believed the subsequent spread widening was overdone, we tactically added some risk.”
Besides the quality of the banks and insurance companies in which we invest, a bond’s technical characteristics are also important. De Moor says: “We look at how the bond is structured. A bank or insurer can issue several types of bond with different risk profiles and we have to pick the one that suits us best.”
De Moor likes banks and insurance companies from the Netherlands, France and the United Kingdom. Although Brexit is casting its shadow over the market, he still sees attractive British banks and insurers to invest in. “But we require a higher risk premium.”
Another risk that De Moor sees for the market in general is the further tapering of the ECB bond buying program. “The ECB has announced that it will continue to buy bonds until September 2018, but at a reduced amount”, says De Moor. “We think that the bonds of banks and insurance companies will act as a safe haven in an environment where Central Banks taper their bond purchasing programs, because of the positive effects that higher rates will have on the financial sector. The ECB is not buying financial bonds and the spreads on credits from other sectors are being artificially lowered by the bond buying program. If further tapering occurs, these spreads will rise.”
Valuations have not yet caught up with the improved fundamental outlook for the European financial sector in particular, with the subordinated bonds of banks and insurance companies trading on an average additional spread ranging between 75 and 200 bps over government bonds with a similar maturity, compared with a spread of 90 bps for global investment grade over government bonds. Additional Tier 1 CoCos issued by banks are even trading at spreads of more than 250 bps.
The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.
The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.
Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is ACOLIN Fund Services AG, Affolternstrasse 56, 8050 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult www.finma.ch for a list of FINMA registered funds.
Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/RobecoSAM AG product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/RobecoSAM AG offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.
This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.