Management company comment about ABLV open-end mutual funds in December

Riga, Latvia, January 7, 2015, 11:20 / Investments

December turned to be a very complicated month in the markets of high-risk corporate bonds and government bonds of emerging countries. The most significant factor that caused a strong sell off in these markets was the continuation of unrestrained fall in oil prices.

Besides, panic in the markets was caused not even by the fact of falling prices (oil prices were gradually decreasing over last six months), but the realization of the fact that prices will unlikely return to the level of USD 100 per barrel in the nearest future and, most likely, remain low for a longer period. This scenario turned to be even more realistic after the announcements made by some representatives of the OPEC countries about their unwillingness to reduce the volumes of oil extraction in spite of falling prices, in order to retain their market share and not to give it to other countries that also extract and sell black gold.

Therefore, due to record-hitting volumes of extracted oil in the USA and remaining high volumes of oil extraction in the OPEC countries, the supply of hydrocarbon significantly exceeds the demand and pushes prices to their minimums of the last six years. If for the majority of developed countries cheap oil is an additional stimulus for the economy growth, as in the long-term production expenses will be reduced, then for the exporting countries it means the decrease of income into the budget and potential worsening of the economy and increase of debt load. Whereas emerging countries are mainly dependent on oil extraction, the bond segment of Emerging Markets both government and corporate turned to be the most suffered ones. The sector of US high yield bonds suffered even bigger losses, as around 16 per cent of this market sector is compiled by the bonds of energetic corporations. Outlooks of keeping the current level in oil prices for a rather long period rapidly increased the expectations of possible defaults among these companies, due to the high level of debts.

The segment of high grade bonds of US and European issuers remained relatively stable due to the support of US Treasuries and Bunds, which yielding continued to decline. Nevertheless, in spite of large share of these bonds in our funds (that was significantly increased in November) general fall in prices in the market resulted in negative results at month-end.

In the segment of Russian corporate bonds a “perfect storm” happened: several negative factors — fall in oil price, falling ruble, sliding down ratings, continuous rhetoric around sanctions simultaneously clashed and led to active liquidation of positions in Russian Eurobonds by the end of the year against the background of the exceptionally low liquidity, leaving no chance to this segment of the market. Everything was being sold and practically at any prices. It is worth to note that at the end of the month in the bonds of good (high-quality) issuers an essential kickback of prices occurred showing emotional oversold of the market.

In the global stock market, high volatility was observed due to general nervousness among investors. Due to their high market capitalization, large oil companies have heavy weight in the majority of the stock indexes of various countries, both developed and emerging; therefore the negative dynamics in the oil industry heavily influenced the market in general. As well as in the bond market, the main blow caught the markets of emerging oil exporting countries. In this regard strong fall of ETF on the fund indexes of these countries is conditioned less by the fall of the indexes but rather by accelerated fall of exchange rates of local currencies. As a result, general index of MSCI EM fell within the month by 4.8 percent. The securities markets of developed countries showed greater stability, even though they close the month in negative.

In regards to 2014, in general, the positive dynamics practically prevailed over the whole year in the global bond markets caused by reduction in yield of Treasuries and Bunds. However, if the reduction of yield of German bonds is rather consistent at the background of the ECB politics, then the similar dynamics in US Treasuries is one of the main surprises of the past year to the majority of the investors. Given the macroeconomic statistics, nobody doubted that a new cycle of interest rates increase by FRS would begin in 2015. Therefore, the price stability in the segment of medium-term US bonds and the price growth of long-term securities took by surprise many analytics. As a result, at year-end the segments of government and corporate bonds with high grade showed best results. In the segments of high yield corporate bonds and government bonds of emerging countries a confident growth was observed in the first half of the year, but December events significantly corrected a general result. December sell off within two weeks reduced yield of investors produced in the first 11 months at least in two times.

Russian corporate bonds should be mentioned separately, during the year they were under pressure of tensed geopolitical situation, introduced Western sanctions, falling oil prices and general worsening of economics. As the result of December sell offs, at the year-end, the yield of even quasi-sovereign bonds grew over the indicator of 10 per cent at the background of significantly falling prices. To our mind, these yields are inadequate according to the fundamental evaluation, but in the circumstances of panic sell offs prices become most important, but yields and loan profiles of issuers are not taken into account at all.

In the global stock market, the market of emerging countries again brought principal disappointment. The main investment idea of the end of the last year was that the emerging markets should show better results than the markets of developed countries, with reference to a serious lag in 2013, when MSCI EM fell by 5.0 per cent against the growth of MSCI World by 24 per cent. During the most part of the year, this investment idea paid off, however at the beginning of the fourth quarter the moods in the market changed radically and resulted in the acceleration of fall in price in the raw material markets. It initiated a new strong wave of exchange rates fall against US dollar that largely determined the negative result of this market segment.

European markets also showed lagging behind dynamics as hopes for faster recovery of the European economy turned to be too optimistic. Here geopolitics and sanctions war of the USA and Europe against Russia were determining. And while the USA was not practically influenced by this (both at macro- and micro- levels), then European economy and the mood of investors were badly influenced. As a result, American fund index S&P 500 showed the growth 2.5 times bigger than European Eurostoxx 600.

In 2015, we are expecting current tendencies in the global bond market to remain. The segment of high grade corporate bonds will remain sensitive to the dynamics of US Treasuries, and the segment of high yield corporate bonds — to the dynamics of stock market.

Taking into account an announced potential increase of key interest rate by the US regulator in 2015, we are expecting a gradual growth of short-term interest rates in US dollars, at this, the level of long-term interest rates in US dollars will depend on the inflational expectations that at the moment are low. One of the reasons for these expectations is the anticipation of possible “deflation export”. However, if stimulating measures taken by the ECB and the Bank of Japan lead to desirable results, then the situation in the market of US Treasuries may possibly change. In the global stock market and high yield bond market, increased volatility is possible in the circumstances of uncertainty in the raw material markets and retained geopolitical tension. Measures taken by monetary authorities of the leading countries will continue strongly to influence the market.

Definite investment decisions within the frameworks of funds portfolio will be made in accordance with the development of the situation in the markets.

Ilmārs Jargans
Head of Public Relations Department
+371 6777 5296
ilmars.jargans@ablv.com