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High-quality European issuers in the high-yield market opened 2 points down this morning after UK’s vote on Brexit. This price reaction is not severe, especially if you relate this to the fierce moves seen in equity markets. We considered the order of magnitude fair, given the strong support by the corporate buying program of the ECB and healthy balance sheet of European BB credits.
The Robeco High Yield Bonds has nearly 25% exposure in Euro-denominated issues. The fund has a quality bias, by having an overweight of BB and higher rated credits. There is a structural underweight in CCC credits, which witnessed severe price drops in relative to high-quality names. ITraxx Crossover, which is a synthetic proxy of the high-yield market opened 100 basis points wider and is currently 80 basis points wider on the day.
What we are seeing in the market is that investors are trying to add exposure. A large part of the investor community has large cash balances, which is slowly been put to work. Problem is that there is not much paper around.
The fund has reduced its beta yesterday to 1, by buying protection in iTraxx Crossover. The portfolio managers witnessed that a Bremain was priced in, so this was a great opportunity to put on a tail-risk hedge.
The tail-risk hedge also acts as hedge to the overweight in financials of nearly 4%, which is an off-benchmark position. Within financials the fund has a very limited exposure to UK banks (1%), which do witness a significant price reaction. The majority of the financial positioning is in non-UK banks.
The fund has limited exposure to credits denominated in sterling (5%). Within this exposure the vast majority is within corporates, which are not as badly impacted as UK banks. 75% of the fund’s exposure is tilted towards credits denominated in US dollar. We expect that this part of the market will be less affected than Europe. The currency exposure of the fund is hedged to the base currency.
Overall the quality bias in the portfolio, together with protection via iTraxx Crossover, should for a large part mitigate the effects of a Brexit. In addition, the fund has ample liquidity measures in place to cope with market volatility.
We strongly believe that being contrarian in these kind of market circumstances, is the right approach. We think that limited market liquidity and the heightened uncertainty around future developments will keep markets volatile, which creates possible trading opportunities.