We continue to overweight the financial sector vs. the non-financial sector, which is currently benefiting from better fundamentals and relatively attractive valuations (though spreads, narrowing rapidly, are at low levels). The financial sector is also supported by improving capital reserves (and asset quality), better margins on the back of rising interest rates, and the regulatory landscape. Moreover, Q4 earnings confirmed the strength of bank balance sheets
Within the financial sector, CoCos remain our instrument of preference, benefiting, as they are, from earnings recovery, lower duration and a weaker correlation to US Treasuries.
With credit spreads at tight levels in both the IG and HY space, convertible bonds are an interesting source of diversification in the current environment. Convertibles could benefit from the upside that equity markets, supported by the better macro context, present, and they have lower sensitivity to rising rates than traditional corporate bonds. We believe that European convertibles offer good value, as European equities have lagged during the current phase of expansion and there is significant upside in the asset class.
The idiosyncratic risk has risen in the US, as the fiscal stimulus still favours equity more than bond holders, and is increasing discrepancy amongst issuers. Moreover, while the effects of Trump’s tariffs on steel and aluminium are balanced between producers and manufacturers and increased issuer dispersion, some sectors are facing secular growth challenges. All in all, selectivity will be key.
In this context of higher market volatility and issuance fears, we believe spreads should continue to widen. Valuation on US credit continues to be tight, resulting in our underweight stance on this asset class.
On the other hand, we prefer to focus on EM debt, as fundamentals – supported by positive global growth and stable commodity prices – remain strong.