Castelli (Banor): Selecting credit risk with care.

Good investment starts with “alpha”

“Interesting opportunities on the European periphery: companies with business picking up and manageable debt pay much higher spreads than northern European companies” Francesco Castelli, manager of the Banor Sicav Euro Bond Absolute Return fund

By Francesca Vercesi

The abrupt, sudden rise – running counter to the action of the European Central Bank – shows that the long-standing downwards trend for interest rates, which has lasted over 30 years, is at an end. We saw a similar event in the summer of 2013 in the USA, when a slight change in the Fed’s language led to a dramatic adjustment in the bond market. That experience also teaches us that the coming months will probably see bonds stabilise.

“But let’s not delude ourselves: the new few years will be difficult”. Speaking is Francesco Castelli (photo), manager of the Banor Sicav Euro Bond Absolute Return fund.

In this turbulent period for bonds, what are your preferred options, and why?
Management strategies focused on duration, which have paid so well in recent years, need to be ditched. We prefer to work on alpha generators, through careful selection of the credit risk.

Which strategies are best to partly absorb the volatility of the market while also performing well?
The European periphery continues to offer interesting opportunities: companies whose business is picking up and with manageable debt levels still pay much higher spreads than similar companies in northern Europe. The market is clearly still concerned about the Greek troubles, which should, however, remain circumscribed. Let’s not forget that Greece represents a paltry 2% of European GDP. Athens is a major political headache but a manageable financial risk.

Turning to the sovereign bonds of European countries, what long positions do you hold? Do you have a position on Italy? And on the corporate front?
European government bonds offer limited value, in our view. The German bund, even after a robust rise, continues to trade at under 1%. In real terms (i.e., net of inflation), we’re talking about negative yields in the order of 0.5%. Pulled upwards by German bonds, our BTPs (Italian government bonds) are, unfortunately, fairly dear at present and hold little appeal: the spreads are back at 2010 levels and we’re struggling to see them narrowing. Taking the scenario (in our view highly likely) of a moderate recovery in the euro area, it would be worthwhile moving from government paper to corporate. We don’t do this indiscriminately, anything but. Periods like this are more for bond pickers than benchmark investment.

So you’re aiming to grasp the yield differential?
We’re definitely looking to credit strategies. Our portfolio has a limited exposure to rate risk (under 2 years’ duration, at present) but a return of more than 4%.

The investments we hold are generally diversified around 30-40 companies that we know very well. In addition to their research and information work, our team meets the management regularly for an up-date on how business is going.

How is the Banor Euro Bond Absolute Return performing and how is the portfolio constructed at present?
The first part of 2015 was highly satisfactory, with a gain of 3.5% to date, much better than any European bond benchmark and most of the bond alternatives outside the euro.

But I believe the greatest satisfaction for our team is that we’ve protected our clients’ capital in periods of falling markets. In the last three months the bond indices and BTPs have seen losses of over 3% (with peaks of 15% on 30-year bonds).

Our portfolio kept volatility within bounds and saw a fall of just 0.2%. The aces in our pack are market niches that have retained value. Subordinated instruments of banks undergoing recapitalisation, industrial businesses that are taking forward deleveraging policies, companies exposed to sectors severely hit by the crisis and now recovering. We are located in the segment we now call “mid-yield”: our portfolio can fall to below investment grade, but in a lower overall risk context than that of classic high yield funds.

Original article in Italian language, available here: Bluerating, August 1, 2015.


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