Carmignac’s wide-spectrum bond expertise has boosted returns following the Covid-19 crisis
Fixed income has always played a vital defensive role, while also being a performance driver within Carmignac’s flagship Patrimoine fund.
Fixed income and money market instruments make up at least 50% of the fund at any given time. The approach is unconstrained, by being global, active, flexible and benchmark agnostic in order to extract value in different market conditions. This wide-ranging approach has helped performance amid the recent market disruption, in particular by finding new investment opportunities in the credit space.
Rose Ouahba has managed the Fund alongside Edouard Carmignac since 2007. Since David Older became the co-manager in 2019, the two have full responsibility for running the fund and work together to determine asset allocation and risk control across the entire portfolio, with input from the firm’s Strategic Investment Committee.
‘Managing downside risk is our key focus,’ said Rose Ouahba. ‘We achieve this partly via our equity exposure, portfolio construction and modified duration management that can range from -4 to +10. But at the same time, our experienced team has the ability to cover a large spectrum of the fixed income asset class. This means we can take a dynamic approach and, depending on our views of the economic cycle, can add alpha via our best ideas in the higher yielding areas as well.’
These areas include emerging markets and credit, as well as collateralised loan obligations. While there are limits on the amount of credit that can be held, the approach is highly flexible. ‘It’s important that we have the right toolkit and expertise to try to generate positive performance in all market conditions,’ Ouahba said.
While in recent years sovereign debt has outperformed, the Covid-19 crisis has created more opportunities for the team’s bottom-up, bond-picking approach on the credit side. Coming out of the March collapse, for example, the team increased credit risk compared to equity risk in selected areas, such as travel and accommodation.
Balancing the cross-asset portfolio construction and risk requires close collaboration between the managers, in particular balancing equity and credit exposure. Ouahba gives the example of a recent position in a cruise company initiated in March 2020.
‘It was a bold call to invest in a cruise company at that point, but it was a strong recommendation from Pierre Verlé, our head of credit, who knew the company very well. He had met Carnival’s management in October 2019 and thought it was a solid company, but at that point the bond was expensive with a yield to maturity of 1%. In March 2020, the yield was roughly 10%. Following our internal analysis on the company’s prospects, I decided to allocate more risk on the Carnival credit security,’ she said.
But in order to take on the increased credit risk, she and Older had to work together to reduce overall equity risk. ‘We are constantly collaborating in this way to decide the best way to incorporate bottom-up ideas and how they affect the overall risk allocation in the portfolio,’ she notes. ‘If David takes on more equity risk, he will always consult me on the overall balance. For example, if he were to increase exposure to cyclicals, we would have to check our exposure there within the bond portfolio,’ she adds.
Indeed, the firm’s culture of collaboration means the managers can decide on the best of its asset classes to implement themes, based on the team’s bottom-up and top down analysis.
Looking forward, the team sees some of the strongest opportunities in credit. Carmignac views credit markets on a five-year investment horizon- the typical maturity for a credit bond- and started the year in cautious mode, with a relatively high implied default rate.
‘We thought we were coming to the end of a long credit cycle, and that there would be higher defaults than the market was pricing in,’ Ouahba said.
This contrasts with many credit investors who began the year more bullish and panicked during March, when the market’s implied default rate rose dramatically.
Currently most of the fund’s fixed income risk is in credit – both investment grade and high yield. Patrimoine favours long-term maturity credit bonds that are positioned to benefit from higher spread compression potential, after spreads widened during the first two weeks of March.
Credit market beta is also managed by buying credit default swaps on indices, which helped shield capital from some of the volatility in March. Holding US sovereign bonds also helps to counterbalance the risk of European corporate credit.
On emerging markets, the team is now cautious, given the decline in capital flows and a fall in exports. Nevertheless, from a macro perspective they are monitoring the situation closely: as the Fed relative balance sheet versus the ECB and the BoJ continues to expand, it could lead to a weaker US Dollar. Additionally, if the European recovery plan drives flows towards Europe, it could lead to a stronger euro versus the dollar too. ‘A lower US dollar would mean a more positive context for emerging markets, especially on external debt where valuations are still attractive,’ Ouahba said
Carmignac Patrimoine is a common fund in contractual form (FCP) conforming to the UCITS Directive under French law. Risk scale: 4 (for the share class A EUR Acc). Risk Scale from the KIID (Key Investor Information Document) from 1 (lowest risk) to 7 (highest risk). Risk 1 does not mean a risk-free investment. This indicator may change over time. Recommended minimum investment horizon: 3 years. Main risks of Carmignac Patrimoine – EQUITY: The Fund may be affected by stock price variations, the scale of which is dependent on external factors, stock trading volumes or market capitalization. INTEREST RATE: Interest rate risk results in a decline in the net asset value in the event of changes in interest rates. CREDIT: Credit risk is the risk that the issuer may default. CURRENCY: Currency risk is linked to exposure to a currency other than the Fund’s valuation currency, either through direct investment or the use of forward financial instruments. The Funds may have specific investment limits, as mentioned in their respective prospectuses. The Fund presents a risk of loss of capital.
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