(All comments and data in the following are per 13/3/2020 unless other is stated)
The indicators for liquidity crisis
Particularly for Norway, the Norwegian Krone (NOK) is at the weakest in newer time to the Euro (EUR), this is extreme. The NOK never did well in global liquidity crisis and this is a severe one.
(Soon: link to article showing the total return of a NOK exposure for a EUR based investor)
On a global level, the OIS spread that gives you an indicator of how easy it is to find liquidity in the American Dollar (USD), has rocketed, indicating that the liquidity in USD is very low.
Long term picture – any change?
More of the same, since the end of the 80ties really. Lower and lower interest rates as lower economic growth and inflation is expected.
Where will the Corona crisis lead the economy?
The China example shows extreme falls in different economic indicators, we expect to see the same in here. The length of the «lock down» will be very important.
What is different this time compared to other global liquidity crisis?
The positive is the central banks and government all over the world are coming in massively with liquidity support. This has never been seen this way before.
In Norway and Sweden, the central banks and the governments came with powerful support mechanisms and actions. This is good and should help to limit the negative effects of the sharp slowdown of activity in the society.
Government and central bank replies – enough?
Central banks are providing liquidity and governments are providing other mechanisms to stabilise the economy and the markets. What they have announced up until now in the Nordics is a good start, but they may have to come with more. They have all said they will do this if needed.
For instance in Norway, the government’s package of measures included, among other things, restoring the Government Bond Fund (SOF), which is mandated to invest in NOK 50 billion in bonds. This tool was last used during the financial crisis in 2007-2009. However, it is a bit unclear when SOF starts its support purchases, but there are probably not many days left to wait. Last time, the structure of the fund was such that 25-65% could be invested in Bank / Finance, while 35-75% could be invested in other industries. Up to 30% could be invested in High Yield with a rating down to CCC +. This package will nevertheless be a welcome contribution to raising liquidity in the market.
Other effects you see?
We notice that some things take longer time these days with a lot of employees working from home. This may lead to some delay before the current initiatives, made to mitigate the crisis effect, will be in place. (See some tips how to succeed with the home office here).
What about credit spreads in the Nordic Fixed Income markets and internationally?
Norwegian IG has spreaded out. For instance Norwegian savings banks have spreaded out around 100bps to around 160bps.
Extending the scope to bank, utility, coco and covered bond spreads, we see they all have severely increased spreads. For instance, the spread for covered bonds have gone from 25bps to 60bps.
FIGURE 1 – Corona (Covid19) respons leads to widening Nordic and international IG spreads
Source: Bloomberg and Alfred Berg, per 18/3/2020.
These widening spreads can be understood as an increased uncertainty on the outlook for the companies due to the breaks that has been slammed on the economy. But as we see this this is mainly because of the liquidity crisis, few dare to buy or have inflows or available cash to buy. This is the same in the USD and the EUR credit market. We are back to levels of the previous crisis, some all the way back to the Euro crisis.
How does it look in the risikier segments like Nordic Fixed Income – Nordic High Yield?
The iTraxx Crossover index has skyrocketed and is now back to 2012 levels in the Euro crisis.
The High Yield market, like the other bond markets, is experiencing very challenging times. Credit spreads for the Norwegian and Nordic “B+”* segment have increased by over 1,000 basis points to over 1,700 bps so far this month.
In the Nordic “BB”* rated segment, spreads have increased by 700-800 basis points.
FIGURE 2 – Corona (Covid19) respons leads to widening Nordic HY spreads
Source: SB1 Markets, per 18/3/2020.
Compared to the European and global B+ segments, the Nordic “B+”* rated segment has widened a lot more. The European B+ segment’s spread level has widened with “only” 400bps.
FIGURE 3 – Corona (Covid19) respons leads to more widening Nordic HY spreads versus European HY
Source: SB1 Markets, per 18/3/2020.
It is interesting to note that the Nordic HY “B+”* rating segment spreads are following the US energy HY spreads. This despite that the oil and gas related Norwegian HY bonds’ part of the total Norwegian market has dropped from around 60% to only less than 20%.
FIGURE 4 – Why are Norwegian HY spreads following the US energy HY spreads?
Source: SB1 Markets, per 18/3/2020.
Having said that, it is difficult to operate with exact prices and spreads in this market. There is very low liquidity globally, even within the investment grade, most try to sell when no one wish to buy.
*In the Nordic High yield market there is very few officially rated issuers or issues. We at Alfred Berg – BNP Paribas Asset Management do our own internal ratings on all our holdings.
How have the Alfred Berg Nordic Fixed Income strategies fared in this market?
Investment Grade Strategies
These are all capital preservation strategies where we expect no credit losses. Our Nordic Investment Grade strategy is down 1,1% year to date. Our Nordic Investment Grade Long Duration strategy is up 3,7% year to date. This due to the falling market yields. This has worked as a hedge to uncertainty on the economy as the market yields then often are falling. The other funds have performed between these two.
High Yield Strategies
These are more risky strategies, where an investor should expect potential credit losses.
Our Nordic High Yield strategy is down 7,7% year to date and our Nordic Crossover strategy is down 4% year to date. The Nordic High Yield strategy entered this crisis with a solid cash position. The strategy also has a large proportion of professional and long-term clients who are aware of the underlying risk and current extreme pricing of single bonds. We consider this customer base to be relatively stable. We also had great subscriptions this past week. As in previous crises, all types of companies are being pulled down sharply, good and bad. But as the market gradually normalizes, we will probably see a greater difference in pricing. Those who were most undeservedly drawn into the fall will be repriced first. It is important to position the portfolio as best you can for this. But right now it is extremely difficult to structure the portfolio the way you would like, due to liquidity. At the beginning of March, the fund had a 13.9% share in oil producers, which is naturally affected by the significant fall in oil prices. Oil prices fall for a number of reasons, the recession expectations and a significant weakening of the demand side, but also of an “oil war” between Saudi Arabia and Russia. The Opec countries had hoped for an agreement to reduce oil production as a result of the downturn in demand, but the negociations broke down. When the existing agreement expires in March, Saudi Arabia and Russia can in practice increase their production as much as they want to capture market shares. The share of the fund in the oil service sector was fairly priced before the worst crisis struck, but it adversely affects the fund. But as the situation is now, there are no companies or industries where to escape, it is about great uncertainty about the duration of the virus outbreak, the long-term effects on consumption and growth and how quickly the various industries regain their footing as the situation begins to normalize. However, past experience has shown that in the longer term such strong price declines represent good buying opportunities, which we see so far today. The problem is that most people are sitting on their liquidity until the uncertainty is reduced.
Nordic Fixed Income fund advantage vs local funds?
Liquidity is normally easier as the liquidity is different in the Nordic markets at different times. This is one advantage of being Nordic instead of only Norwegian or Swedish. Of course, in the current market environment liquidity is a challenge everywhere.
Outlook for Nordic Fixed Income?
Hard to say, but the initiatives from governments and central banks should help to stabilise the markets. We see a lot of good value on the mid term dispite the hard effects of the «lock down» of the economies. Should confidence and liquidity come back, current levels could be interesting. But the x-factor is how long this will last.
Risk when you invest in fixed income credit
Capital risk: the risk of capital loss because a unit may be sold at a price below that originally paid to buy it. There is no guarantee that unitholders will get back the capital they invested. Should these risks materialize, the net asset value of the UCITS may fall.
Interest rate risk: because of its composition, the Fund is exposed to interest rate risk. Interest rate markets move in the opposite direction to interest rates. If interest rates rise, the Fund’s net asset value will fall. The impact of interest rate movements is measured by the Fund’s “sensitivity” range, which in this case is on a scale of 0 to 5. The sensitivity measures the impact of a 1% change in interest rates on the Fund’s net asset value. A sensitivity of 5 means that a 1% rise in interest rates would be reflected by a 5% fall in the Fund’s net asset value.
Credit risk: the portfolio will be invested in private bonds and other securities issued by private issuers. Credit risk is the risk that the borrower may default. The Fund is consequently exposed to the risk that some issuers may default on the payments they promised to make on the securities they issued. The deterioration in the financial position of an issuer whose securities are held in the portfolio will result in a drop in the net asset value of the Fund.
Risk relating to investments in “high-yield” securities: the Fund must be considered, in part, as speculative and aimed at investors who are aware of the risks inherent in investing in securities whose ratings are low or non-existent. As such, holding high-yield securities entails the risk that net asset value may fall substantially.
Risk relating to over-the-counter transactions on transferable securities: some derivatives markets known as “over-the-counter” markets, in which the Fund proposes to trade, do not offer the same degree of safety as regulated markets that operate on a regular basis, and are recognized and open to the public. Settlement/delivery transactions appear more risky due to there being no clearing house guaranteeing their completion. A default in such settlement/delivery transactions can cause the Fund’s investments to lose value and the portfolio’s net asset value to fall.
Foreign exchange risk (up to 100% of the Fund’s net assets): this is the risk that the exchange rate of the currency in which the financial instruments in the Fund are denominated may weaken, causing the Fund’s net asset value to fall.
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