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Vontobel's credit chief: why peripheral banks are my top play

Vontobel's credit chief: why peripheral banks are my top play

'Modesty is a virtue’ isn’t a phrase you hear too often in the financial industry. Mondher Bettaieb, however, is something of an exception. He describes his strategy as ‘nothing extraordinary’; he just makes sure his credit selection is thorough and maintains a strong emphasis on value.

He might be underselling himself a little, as his Vontobel – EUR Corporate Bond Mid Yield fund comes an impressive second in total return terms over the past three years out of the 21 funds we track in the bonds – euro corporates sector.

Bettaieb began running the fund in 2010 and has maintained a consistent investment approach throughout his reign, even in the face of huge swings of sentiment around central bank policy emanating from Europe and the US.

When Bettaieb took over the strategy, the fund had €50 million in assets under management, which rose to €1.9 billion over the following seven years. He was the one who recommend the shift to corporates, and in doing so created the first pure credit strategy at Vontobel.

He gained his credit training as an analyst at Bank of America and Rothschild AM in London. His career started in the 1990s, and he says it was immediately obvious to him that a good grasp of credit analysis was a must-have for anyone in the investment industry.

Understanding banks remains absolutely crucial, he adds, as the banking system is at the heart of the economy and directly impacts its overall wellbeing.

‘Having credit analysis experience has helped a lot, as at BoA for example I received training in both banks and corporate credit. This aids our investment process just as that focuses on credit selection,’ he says.

In tune with the ECB

Bettaieb’s understanding of the mechanics of one bank in particular – the European Central Bank – has arguably defined his performance over the past seven years more than any other factor.

At the beginning of June 2017 the fund took a hit when the yields in Europe moved up a bit as people started worrying the ECB might start tapering in September. However, Bettaieb didn’t change the fund’s duration and kept credit exposure more or less the same.

‘We shouldn’t be afraid of tapering, because in any case in 2018 the ECB will remain in the market and continue to buy.’

The ECB unquestionably has a vast impact on the credit market, Bettaieb says, as it buys almost €2 billion of corporate bonds a week.

‘Investment banks that syndicate new bonds treat the ECB as a large asset management account, but they don’t give it everything, leaving quite a good portion of new issues for other investors. Of course, it has had a positive effect on spreads in a sense that there is a constant buyer in the market.’

The prospect of the ECB reducing its asset-purchase programme doesn’t worry Bettaieb. This is despite expectations that the ECB may reduce its purchases from €60 billion a month to €40 billion a month next year, and drop the monthly figure by another €20 billion after six months if inflation were to pick up.

‘This translates into €360 billion of assets purchased in 2018. But people tend to forget that even if the ECB reduces its purchases it will still continue reinvesting the proceeds of bonds it bought already,’ he says. ‘Around €120 billion of bonds are expected to mature next year.’

Altogether, new bond purchases and reinvestments might total €500 billion in 2018, Bettaieb believes. In the meantime, major European countries are expected to issue €720 billion worth of government bonds, of which €600 billion will mature in 2018.

‘Net issuance at the government bond level will be only €120 billion in the end. In addition, €110 billion net issuance in the corporate bonds sector is expected in 2018. This supports a certain bias on the demand side.’

Although Bettaieb says spreads have tightened in recent months, there are other drivers in Europe sustaining the market.

‘Consumers spend more, which translates into positive PMIs that in Germany, for example, are hitting all time highs. Service PMIs in France and Spain picked up quite a bit following the election of Macron that spurred further optimism in Europe.’

Bettaieb says the health of European corporates and banks has also improved significantly.

‘The upgrade/downgrade ratio is currently two, which means for each downgrade there are two upgrades. This shows you that the creditworthiness of European industrial corporates and financial institutions has improved considerably.’

He adds that despite the ECB buying quite a few corporates it hasn’t yet started on banking names. According Bettaieb the allocation to banks is what drove the outperformance of the fund over the years.

‘Some people thought that Italian banks represent some sort of systemic risk for European banking. In the end the story ended really well, with Veneto banks being resolved and transferred locally and Monte Paschi being recapitalised. I would say the systemic issues of Italian banks disappeared.’

Bettaieb’s consistent approach has also been a major factor in the fund’s outperformance. The fund manager doesn’t change his exposure often, not even when the market turns against him as he usually sticks with his bets long term.

This was the case in November 2016, when yields went up temporarily due to heightened market expectations of reflation causing a dip in the fund’s performance.

He says at the time 10-year treasuries went up to 2.6% and now they are closer to 2%, while the bund went up to 0.6% and shortly went down to 0.3%. He expected the yields to come down and the dip disappeared as he kept positioning more or less the same.

‘Our duration is always very near to the benchmark. One typical mistake you can make as a credit fund manager is not sticking to your guns and reducing duration a bit because you are scared.’

Spanish banks

Bettaieb likes the banking sector in Spain as the country’s economy is doing much better than it was a few years ago, while its residential real estate problems have started to stabilise. Spanish banks also have lower costs and lower provisioning requirements, which allows them to book larger profits.

One of the names Bettaieb backs in the space is Caixa bank, which he says has managed to absorb many smaller banks successfully.

‘It’s a regional bank that started expanding to Portugal. Caixa issued quite a lot of capital, and as a result its capital ratio went up to more than 12%, which is relatively strong compared to the ECB requirements.

‘If you translate it in euro terms it is a €5 billion cushion and in order to start impairing its capital, it would have to lose €5 billion a year, which is very unlikely.’

The penetration of the bank is really good in terms of customers’ deposits, and it has very little senior debt outstanding, he adds. ‘Caixa funds most of its balance sheet with customer deposits, which is a very strong position to be in.’

Italian and Spanish sovereigns

Sovereign bonds from European peripheral countries have credit-like characteristics and yield around 1.5-2%, meaning they are firmly on Bettaieb’s radar.

‘The European economy is doing better and sovereign credits, especially in Spain, are improving – that is what we like.’

He adds that Italy still has some issues to work on, but its economy should begin to grow at 1.4-1.5% a year regardless.

‘We haven’t seen such growth for quite some time, there are still some political issues but I think these should be resolved. In addition, the liquidity characteristics are also quite attractive and banks can now lend more at very competitive rates.’

Although Italy lags countries such as Spain on the issue of labour reforms, Bettaieb believes the country will turn the tide as Italians have no lack of creativity when it comes to problem solving.

‘Italy probably had too many governments but in the end it seems to be working. They still experience competitiveness issues, yet what they produce seems to be refined and quite attractive globally.’

Contingent Convertibles

Exposure to traditional convertible bonds in the fund has been reduced recently. However, contingent instruments such as AT1s issued by banks still look attractive, Bettaieb says.

‘AT1s are not like traditional convertible bonds. Our rationale for holding convertible bonds in the past was that the equity market would do relatively well, we wanted to participate in this upside and basically used convertibles as BB proxies to do it.’

A factor making the bonds particularly attractive was that the ECB opted to ease Pillar 2 requirements, meaning banks had to hold less capital.

‘We thought the quality of European banks would continue to improve, and in the beginning of the year the yields and spreads of those AT1s were quite attractive as the ECB relaxed the regulation, which helped the asset class quite a lot.’

This meant the capital cushion of the banks began to increase, he adds.

‘Investors started noticing this, saw less risk in those types of instruments and wanted to participate in the higher yielding instruments.’

Bettaieb describes the current chapter of the European banking as ‘quite boring, but steady’ as most banks have become regional, take less risk and are able to manage their costs well by taking advantage of digitisation.

Car manufacturers

While many investors reacted to 2015’s Volkswagen scandal by panic selling, Bettaieb saw an opportunity to add exposure.

‘The fundamentals of Volkswagen remain quite strong and it generates so much cash flow that we thought despite potential fines that the company might face, it should be able to rebound in the course of two or three years. The spread actually widened quite a lot, we added exposure on the hybrid side and this worked really well for us.’

On the subject of the potentially heavy fines faced by the big German car manufacturers, Bettaieb says the critical factor is exposure to the US market. That’s why he believes companies such as Renault are relatively insulated, as it is more exposed to the European market.

‘We also hold Jaguar Land Rover, which has some exposure to the US market, but this company is not affected by the same issues as Volkswagen. This is a car manufacturer that has been upgraded from B to BB. With this name we were playing the spread contraction relative to the improving credit quality and credit rating.’

Although Fiat is struggling with its own issues, he believes it has a lot of hidden value. ‘Fiat wants to list its car parts manufacturer, which could give it quite a lot of money. Even if the company is fined, it should not have an impact on its credit quality.’

This article was first published in the October 2017 issue of the Citywire Switzerland magazine.

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