Tom Ross, Co-Manager of the Henderson Horizon Euro Corporate Bond Fund, and Vicky Browne, Fixed Income Analyst, look at the impact of the European Central Bank’s corporate sector purchase programme (CSPP).
What is the CSPP?
The corporate sector purchase programme (or CSPP as it is commonly known) was established by the European Central Bank (ECB) and began purchasing bonds on 8 June 2016. The CSPP is a form of monetary policy, which aims to help inflation rates return to levels below, but close to, 2% in the medium term and improve the financing conditions of economies within the Eurozone.
Purchases can be made in both the primary and secondary market. By the end of July 2016 – eight weeks into the programme – secondary market purchases formed 94% of purchases with only 6% being made in the primary market according to data from the ECB.
Which bonds are eligible for purchase?
Bonds purchasable under the scheme must be investment-grade euro-denominated bonds issued by non-bank corporations established (or incorporated) in the euro area. In assessing the eligibility of an issuer, the ECB will consider where the issuer is established rather than the ultimate parent. Thus an issuer incorporated in the Euro area, but whose ultimate parent company is not established in the Euro area, such as Unilever, is deemed eligible for purchase.
How have markets responded to CSPP so far?
To date the ECB has bought 478 bonds totalling approximately €11.85bn from 165 issuers (UniCredit as of 27 July 2016). The list of these bonds (but not the quantities purchased) is available on the websites of the national central banks performing the buying. Analysing these holdings would suggest that, on an industry sector basis, considerable CSPP purchasing has occurred in utilities and consumer non-cyclicals.
In June non-financial credit spreads initially responded positively to the CSPP purchases. However, excess credit returns over the month (returns over equivalent government bonds) detracted from total returns as market volatility increased as a result of the UK voting to leave the EU. Concerns surrounding the vote led to a temporary pull-back in demand for credit and this negative headwind overpowered the positive technical effect from CSPP.
July proved to be a stronger month for credit market performance. The European investment grade market – as measured by the BofA Merrill Lynch Euro Corporate Index – delivered a total return of +1.68% in July in euro terms and excess credit returns of +1.61% (source: Bloomberg at 31 July 2016). Undoubtedly, these positive movements have been partly driven by CSPP purchases as illustrated by the graph below. It reveals how spread performance – a declining spread indicates stronger returns – of the iBoxx Euro Corporate Index has been more pronounced in eligible bonds than non-eligible or senior bank assets.
However July’s returns are not just attributable to the technical support provided by the CSPP. An improvement in market sentiment driven by reduced fears about Brexit, together with a rise in flows into bond funds, has helped to increase demand for the asset class at a time when there is a lack of European investment grade supply.
How has the fund benefited from CSPP?
The Henderson Horizon Euro Corporate Bond Fund was positioned long credit and duration risk versus the index throughout June. Although the fund still trades with a long beta bias we have lowered risk levels over the past few weeks by reducing exposure to positions that have benefited from the recent rally in credit markets. Examples of these are euro-denominated bonds from utility companies Centrica and Redexis Gas, and US real estate investment trust WP Carey.
In July, the fund added to positions from CSPP-eligible issuers on a name-specific basis such as Aroundtown Property, Telenor and RELX Group. Exposure has not just been increased in CSPP-eligible issues but also in companies we favour that are not incorporated in the euro area, such as US names AT&T (in EUR) and Comcast and CVS Health (in USD). The CSPP technical has also been apparent in the primary market. The fund benefited in July from participating in a euro- denominated new issue from Deutsche Bahn, which has performed strongly post issuance. Positive fund performance has also come from a new issue from Teva Pharmaceuticals, which has seen solid demand since coming to the market.
While CSPP should help to provide technical support to European investment grade corporates, there exist several uncertainties in the market – such as the October referendum in Italy and instability in commodity prices – that could cause weakness to arise. We therefore continue to look to reduce risk into further strength while seeking to take advantage of any attractive opportunities presented by volatility or weakness.