MFS Meridian® Funds Euro Credit Fund - Why Now for the Asset Class and Euro Credit
With central banks in a rate cutting cycle, Owen Murfin explains why European credit is providing attractive opportunities and how the fund is actively positioned to invest in the key themes.
MFS Meridian® Funds – Euro Credit Fund - Why Now for the Asset Class and Euro Credit
THIS INFORMATION IS FOR MARKETING PURPOSES ONLY.
RECORDED ON 4 SEPTEMBER 2024
Important Risk Considerations
The fund may not achieve its objective and/or you could lose money on your investment in the fund. Bond: Investments in debt instruments may decline in value as the result of, or perception of, declines in the credit quality of the issuer, borrower, counterparty, or other entity responsible for payment, underlying collateral, or changes in economic, political, issuer-specific, or other conditions. Certain types of debt instruments can be more sensitive to these factors and therefore more volatile. In addition, debt instruments entail interest rate risk (as interest rates rise, prices usually fall). Therefore, the portfolio's value may decline during rising rates. Portfolios that consist of debt instruments with longer durations are generally more sensitive to a rise in interest rates than those with shorter durations. At times, and particularly during periods of market turmoil, all or a large portion of segments of the market may not have an active trading market. As a result, it may be difficult to value these investments and it may not be possible to sell a particular investment or type of investment at any particular time or at an acceptable price. The price of an instrument trading at a negative interest rate responds to interest rate changes like other debt instruments; however, an instrument purchased at a negative interest rate is expected to produce a negative return if held to maturity. Derivatives: Investments in derivatives can be used to take both long and short positions, be highly volatile, involve leverage (which can magnify losses), and involve risks in addition to the risks of the underlying indicator(s) on which the derivative is based, such as counterparty and liquidity risk. High Yield: Investments in below investment grade quality debt instruments can be more volatile and have greater risk of default, or already be in default, than higher quality debt instruments. Geographic: Because the portfolio may invest a substantial amount of its assets in issuers located in a single country or in a limited number of countries, it may be more volatile than a portfolio that is more geographically diversified. Please see the prospectus for further information on these and other risk considerations.
What is the Fund?
So having managed global credit assets for over a decade, we made a decision in early 2019 to launch a more regionally focused European credit fund. The objectives of this fund are to outperform the Bloomberg European Aggregate Corporate Index by a hundred to 125 basis points, and in order to do that, we believe we need to take track and error between 50 and 300 basis points. We have limited exposure to high yield, but at all times that’s less than 15%, and our duration profile is similar to that of the benchmark. Our philosophy focuses very heavily on security selection and on empowering our analysts and adopting the best ideas into the portfolio. They also benefit from strong collaboration with other areas of MFS such as ESG professionals, our equity colleagues and our quantitative research professionals. I’m pleased to say that after five years since the launch of the fund, we’ve successfully achieved our objective, and the attribution shows that most of our returns have come from where we want them to in our objectives. So namely security selection.
Why the Fund?
So what clients need to remember is we are now in a tighter spread environment. Spreads are some 40 basis points tighter here to date. And spread levels are almost half those at the peak of the Ukrainian conflict and when concerns were very high in 2002 on inflation. So most of the forward-looking returns are likely to come from a combination of carry and yield, but also the alpha that active managers can create.
The good news from this perspective is there are a number of active themes that we can take advantage of, and they’re showed here in this slide. And just to pick on a few of the themes, things like European bank consolidation, some of the strong balance sheets and cash flow that we see in sectors like metals and mining, but also other themes like the deleveraging of European real estate companies. Looking at our portfolio specifically at the moment, we have quite low levels of risk, around 60 basis points of track and error with limited exposure to non-investment-grade securities around 5.5%. And there we focus really on the best idiosyncratic themes of our analysts.
At the moment, we still prefer financials relative to industrials and have a preference for noncyclical sectors like, for instance, food and beverage relative to more cyclical sectors like automakers, and as mentioned previously, we do like European real estate. We think there is a deleveraging theme here, and I’ve been impressed by the way companies have cut dividends sold assets to help them to reduce the leverage on their balance sheets.
Why now?
So we certainly feel, as an asset class, European credit is very compelling relative both to European government bonds and cash currently. It is also notable that spreads in Europe remain cheaper than in the US, which is somewhat unusual. As you can see from this slide as well, the attractive starting point for clients invest in the asset class means that future returns should be quite healthy. There’s a clear correlation between starting yields and subsequent five-year annualised returns. And you can also see from this chart the chance of loss, given the high starting yields, is low. Other positives for the asset class are limited levels of supply relative to continuous demand. We have seen a lot of supply front loaded so far in 2024, and we expect supply in the asset class to be less going forward as companies de-lever.
Against that, we have continuous levels of demand from retail investors and large institutional investors like defined benefit pension schemes. And then lastly, the fundamentals of the asset class are attractive. Things like interest coverage liquidity on balance sheets remain very strong and this could provide resilience to the asset class, particularly in the event of a recession.
So thank you very much for listening and we very much look forward to keeping the dialogue going in the future.
Disclaimer
Credit Quality Methodology: For all securities other than those described below, ratings are assigned utilizing ratings from Moody’s, Fitch, and Standard & Poor’s and applying the following hierarchy: If all three agencies provide a rating, the consensus rating is assigned if applicable or the middle rating if not; if two of the three agencies rate a security, the lower of the two is assigned. If none of the 3 Rating Agencies above assign a rating, but the security is rated by DBRS Morningstar, then the DBRS Morningstar rating is assigned. If none of the 4 rating agencies listed above rate the security, but the security is rated by the Kroll Bond Rating Agency (KBRA), then the KBRA rating is assigned. Other Not Rated includes other fixed income securities not rated by any rating agency. Ratings are shown in the S&P and Fitch scale (e.g., AAA). All ratings are subject to change. The portfolio itself has not been rated by any rating agency. The credit quality of a particular security or group of securities does not ensure the stability or safety of an overall portfolio. The quality ratings of individual issues/issuers are provided to indicate the credit-worthiness of such issues/ issuer and generally range from AAA, Aaa, or AAA (highest) to D, C, or D (lowest) for S&P, Moody’s, and Fitch respectively. The index rating methodology may differ.
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