In the last year, we have seen both a sharp rise in the rate of inflation and an unexpected persistence in this increase. The war in Ukraine has compounded inflationary pressures as a result of the rising cost of energy and certain raw materials, both lowering European economic growth. The European Central Bank, which has not yet changed interest rates, has announced that it will start raising them in July.
It is in this environment that the month of June brought an end to the worst quarter and half-year in fixed income in the last 20 years. Sharp falls affected both sovereign debt and corporate credit, closing the first six months of the year with double-digit drops.
So far this year, sovereign debt interest rates have risen sharply all along the yield curve. With respect to Spanish sovereign debt, for example, the 2-year Treasury bond has gone from offering a negative yield of -0.55% at the beginning of the year, to a 0.94% yield at the end of June, which represents a drop close to -3% in prices. The same phenomenon has occurred in bonds with longer maturities, with even greater price declines.
While they are still relatively low interest rates, they are already more 'normalised'. In fact, we have not seen these levels of interest rates for Spanish 2- and 10-year debt since 2013/2014, when Europe was emerging from the greatest sovereign debt crisis in its history.
With respect to corporate credit, the risk premiums, i.e., the yield spreads of these assets over sovereign debt rates, have doubled compared to the levels observed at the beginning of the year. It appears that the market is anticipating an increase in insolvency rates, but at present, they are still below 1%, or, close to historical lows.
This widening of credit spreads, together with the rise in sovereign rates, has raised the average yield of both 'Investment Grade' and European 'High Yield' credit.
The good news is that government bonds are no longer offering negative returns and are once again making sense as a safe-haven asset. In addition, investment in corporate credit offers investors both more attractive returns and greater protection against potential interest rate rises or increases in risk premiums.
For conservative fixed income funds, such as EDM Ahorro, these rises in interest rates, both in sovereign debt and in credit, are important, since they allow for truly conservative strategies to be implemented and limit duration, credit and liquidity risk, achieving attractive returns.
At EDM Ahorro, we implement a strategy that allows us to maintain a flexible and balanced portfolio, in other words, we adapt it according to our expectations, whatever they may be at any given time. We currently hold the majority of our portfolio in more defensive strategies. These involve assets such as sovereign debt, money market funds and 'Investment Grade' credit bonds, which have a higher correlation with the movements in sovereign debt. We have taken advantage of recent rate hikes to raise the average credit quality of the portfolio and extend the duration of the fund to some extent.
On the other hand, we keep a small percentage of the fund invested in 'value' strategies. These involve high-yield bonds or mid-cap companies that, after a strict analysis by our team of analysts, offer very attractive low-risk returns.
We believe that a fund like EDM Ahorro, with its history and flexibility, is perfect for adapting to a volatile and uncertain market environment, and is a great alternative for the conservative part of our clients' portfolios.
Anna Karina Sirkia,
Fixed Income Fund Manager
