High Income Bond Fund Class C (Dist) Investor Shares in USD

The Fund aims to maximise the total level of return for investors by investing, mainly in a diversified portfolio of bonds and other similar debt securities. In pursuing this objective, the Investment Manager shall invest primarily in a diversified portfolio of corporate & government bonds maturing in the medium term, with an average credit quality of “Ba3” by Moody’s or “BB-” by S&P, although individual bond holdings may have higher or lower ratings. The Fund can also invest up to 10% of its assets in Non-Rated bond issues.

The Fund is actively managed, not managed by reference to any index.

The Fund is classified under Article 6 of the SFDR meaning that the investments underlying this financial product do not take into account the EU criteria for environmentally sustainable economic activities.

The Investment Manager of the CC High Income Bond Funds – EUR and USD has the duty to ensure that the underlying investments of the funds are well diversified. According to the prospectus, the investment manager has to abide by a number of investment restrictions to safeguard the value of the assets

• The fund may not invest more than 10% of its assets in securities listed by the same body
• The fund may not keep more than 10% of its assets on deposit with any one credit institution. This limit may be increased to 30% in respect of deposits with an Approved Institution
• The fund may not invest more than 20% of its assets in any other fund
• The fund may not carry out uncovered sales (naked short-selling) of securities or other financial instruments

September 2023

Introduction

Following a seemingly robust start to a second half of the year, market volatility – primarily reflecting the renewed stress on a weaker macroeconomic backdrop and sovereign bond yields heading higher – took centre stage. The latter, a consequence of uncertainty surrounding central banks’ policy moves. Inflation, although not the sole indicator guiding policy decisions, remains a crucial factor in determining the duration of elevated interest rates. The mantra of higher rates for longer to-date sticks.

In September’s policy meeting, the European Central Bank (ECB) hiked interest rates for a tenth consecutive time, yet signaled that it is likely done tightening policy as inflation has started to decline but it is still expected to remain “too high for too long”. Consequently, setting the main refinancing operations rate at 4.5%, a 22-year high. Meanwhile, the Federal Reserve kept the target range for the fed funds rate at a 22-year high of 5.25-5.5%, in line with market expectations, but signaled there could be another hike this year. Projections released in the highly anticipated dot-plot showed the likelihood of one more increase this year, then two rate cuts in 2024.

From a performance viewpoint, government bond returns were negative across developed markets as yields rose notably over the quarter. High yield bond markets remain the top performing sector this year, with European and US benchmarks returning c. 6.12% and 5.98%, respectively so far in 2023. In a rising yield environment, the shorter-dated profile of high yield bond benchmarks proved to be a source of resilience, with spreads broadly flat over the quarter.

Market environment and performance

Concerns of a potential recession, which had been somewhat dismissed earlier in the year due to the resilience of economic activity, have now reemerged. The downward revision of the Q2 GDP growth rate, mainly attributed to weak exports and stagnant domestic consumption, has contributed to these worries. The ongoing decline in private sector activity has further cast doubt on the likelihood of a positive Q3 growth rate figure. Purchasing Managers’ Index (PMI) indicators continued to show signs of weakness amid a second successive contraction in services (reading 48.7 v a previous month reading of 47.9) for 2023 and a continued downturn in manufacturing (reading 43.4 v a previous month reading of 43.5). Overall, new orders dropped while backlogs of work experienced the largest decline since June 2020. The rate of job creation was the joint second-slowest in the current 32-month sequence of growth. From an inflationary front, input prices accelerated, while selling prices rose the least in over a year consequent to a weak demand environment.

Despite a notable increase in oil prices, there were positive developments on the inflation front, as year-on-year core measures showed signs of easing in the majority of economies. Annual inflation rate in the Euro Area declined to 4.3%, reaching its lowest level since October 2021 and below market estimates of 4.5%. Prices increased at a slower pace for services, non-energy industrial goods, and food, alcohol & tobacco. Core inflation – a highly monitored figured by the ECB – eased, dropping to 4.5% from 5.3% in the previous month.

In the U.S., the economy – while still revolving in expansionary territory – nearly stalled due to a weaker expansion in the services (50.2 v 50.3 in August) and a sustained contraction in manufacturing (49.8 v 47.9 in August). Total inflows of new business declined the most since December 2022, and outstanding business dropped at the sharpest rate since May 2020. Meanwhile, the rate of job creation accelerated, amid some reports that staff retention was improving. Regarding prices, cost pressures ticked higher again, as input prices rose at a marked rate. The rate of output charge inflation however proved softer than those seen on average as weak client interest stymied firms’ ability to hike selling prices.

Annual rate of inflation in the US remained steady at 3.7% in September, defying market expectations of a slight decrease to 3.6%, as a softer decline in energy prices offset slowing inflationary pressures in other categories. Core inflation which excludes volatile items such as food and energy however eased to 4.1%. From the employment front, hiring increased by 336k, well above an upwardly revised 227k in August, and above forecasts of 170k, signalling a resilient labour market despite the Fed’s tightening campaign. Meanwhile, the unemployment rate and labour force participation rate remained stable at 3.8% and 62.8%, respectively. The nominal wage growth (4.2%) showed signs of easing, increasing below market estimates.

From a performance viewpoint, credit markets had a relatively weak month, with European investment grade pricing in a bleaker economic outlook, leading to negative total returns. US investment grade too saw losses; -2.45%, underperforming its relative counterpart. High yield credit – the riskier bonds as determined by credit rating agencies – outperformed, aided by the lower interest rate sensitivity. European and US high yield credit returned +0.32% and -1.16%, respectively. 

Fund performance

In September, the CC High Income Bond Fund headed lower, recording a loss of 0.68% from the previous month’s close.

Throughout the month the Manager continued to take opportunity by re-tapping selective names which do offer value, notably, those which have only recently sought to refinance with coupons now more aligned to the current market environment. Also, allowing to increase the portfolio’s duration in a balanced manner. The manager has over the month increased its exposure to United Group, Loxam Group, and automotive manufacturing company ZF Friedrichshafen.

In-line with the fund’s dividend policy, to distribute a dividend on a semi-annual basis, the Manager declared a distribution of 4.50% (annualised).

Market and investment outlook

Investors entered the quarter optimistic that the Federal Reserve (Fed) had orchestrated a soft landing for the economy, and that the era of policy tightening rates would soon end. That enthusiasm withered at the tail-end of the quarter, however, as the prospect of a sustained period of higher rates sank in. This followed a revised Fed “dot plot” showing the likelihood of one more increase this year. The ECB, albeit acknowledging that inflation has started to decline, expects interest rates to remain elevated, and at sufficiently restrictive levels for as long as necessary.

From a monetary standpoint, the prevailing expectation is that any future interest rate hikes, if they occur, could potentially signal the conclusion of a relatively aggressive cycle aimed at addressing what was initially believed to be temporary inflationary pressures. The primary focus remains on the economic landscape and how such tight monetary policy will impact the economy. Previous positive sentiment now appears to be waning as the possibility of a more severe economic slowdown looms on the horizon.

As previously conferred, the fixed-income asset class remains an attractive investment proposition. Expectations of a decorrelation phase between bonds and equities augurs well for the segment in 2023. In terms of bond picking, the Manager will continue to assess the market landscape and capitalize on attractive credit stories. Similar to actions taken in recent weeks, the Manager will continue adjusting the portfolio to align with the prevailing yield environment. From a duration perspective, the Manager maintains the view that given the as-yet sticky inflation, duration-increases will only be implemented in a measured and gradual manner.