MACRO AND MARKET REVIEW
June proved to be another constructive month for fixed income investors, with improvements in the Middle-East providing respite. Government bond markets continued the recovery from their war induced volatility, while credit moved marginally wider on the month despite improving sentiment around energy markets. Euro-denominated assets again outperformed many USD counterparts, supported by stronger duration performance in lieu of a softening inflation outlook and a retracement in energy prices.
The key development during the month was the signing of a Memorandum of Understanding (MoU) between Iran and the US, opening a 60-day ceasefire agreement to allow for further negotiations towards a longer-term peace agreement. Following the MoU, vessel traffic partially resumed through the Strait of Hormuz and oil markets responded swiftly, as brent crude fell sharply back towards pre-conflict levels. While negotiations remain ongoing and sporadic security incidents continue to highlight the fragility of the situation, markets increasingly viewed the worst-case energy supply scenarios as less likely.
The moderation in energy prices was particularly important from a macroeconomic perspective. Inflation concerns had dominated market discussions throughout the second quarter, but June data provided the first signs that the energy shock may not spread broadly as had been feared. Eurozone headline inflation slowed to 2.8% from 3.2% in May, while core inflation also eased. Across the Atlantic US inflation was similarly well behaved, showing little sign of broader pass through. Ultimately, although price pressures remain above central bank targets, the direction of travel was encouraging and helped support a broader rally across duration markets, particularly in Europe.
Central banks nevertheless maintained a cautious stance. The ECB raised its deposit rate by 25bps to 2.25%, citing continued inflation risks stemming from the energy shock and a desire to keep inflation expectations anchored. The Federal Reserve left rates unchanged, with policymakers signalling concern that inflation remains above target alongside a still-resilient economy. Despite the progress on the war and inflation front, both decisions emphasised that inflation concerns still trump growth concerns in eyes of central banks.
June also marked the first Federal Reserve meeting under new Chair Kevin Warsh. While rates were left unchanged, the Fed adopted a more hawkish tone, removing language that had previously pointed towards eventual rate cuts. Warsh also signaled a reduced emphasis on forward guidance, declining to participate in the Fed's traditional "dot plot" projections and stressing a more data-dependent approach to policy. The move away from explicit forward guidance will likely lead to more volatility in front end US rates in the coming years, a trend that is likely to heavily shape future fixed income performance.
PORTFOLIO ACTIVITY
Q2 proved to be considerably less volatile than the previous quarter. After spreads widened materially following the US attack on Iran and associated actions at the end of February and beginning of March, we saw a general tightening of spreads throughout the quarter with many bonds now at or even tighter than pre-war levels. We followed our own advice from last quarter’s newsletter and remained largely inactive, holding our existing positions, given our confidence in our own credit assessment while seeking to pick up additional paper at attractive prices. As spreads tightened through the quarter, we reduced risk a little and took profit from those names that had tightened the most, recycling the cash into names that were slower to recover and new issues. Interestingly, throughout this entire period the new issue market has remained open with demand from investors generally very strong. We highlight a few of the more interesting investments below:
We sold Swiss chocolate manufacturer Barry Callebaut after strong Q1 results which showed a material improvement in credit metrics as the price of cocoa, its primary cost component, has fallen materially. As a result, the market believed a downgrade to high yield was unlikely and spreads tightened substantially.
We also sold our holdings in Forvia; a high-yield auto-parts supplier which has also tightened beyond where we considered fair value given the challenges facing the automotive sector.We added positions in a number of names including:
Integrated paper, packaging and forest products company Stora Enso is a leading provider of renewable products and one of the largest private forest owners in the world. It has an implied temperature rise (ITR) and carbon investment ratio (CIR) well below the sector average at 1.5 °C vs 3.0 °C and 448 tCO2e per MUSD invested vs 1,486. Stora Enso issued a corporate hybrid to support a strategic balance sheet repositioning ahead of the planned separation of the forest assets. We believe this action, combined with the company's diversified business model, strong packaging exposure, and explicit commitment to maintaining solid investment-grade ratings will support investment-grade ratings going forward.
General Mills is a leading global manufacturer and marketer of packaged food products with ITR (1.6 vs 3.0) and CIR (319 vs 1,165) well below the sector average. The company issued hybrid bonds to refinance senior debt which is supportive of credit metrics as the rating agencies split hybrid issues 50:50 between debt & equity in their credit calculations. This new issue was priced too tightly in our view so we did not initially participate but stepped in when the issue widened to our price target shortly after launch
Adecco is a leading global staffing and human resource company with a very small carbon footprint of just 61 tCO2e per MUSD invested. The company issued a new hybrid bond to refinance and replace its existing hybrid bond which will help to preserve its investment grade rating.
Brazilian beef producer Minerva has a very low ITR (1.2 °C) but a very high carbon footprint (1,736 vs 1,165 sector average). As a high emitting company that has a credible decarbonisation plan, we look to be supportive here. We like the underlying credit thanks to its increasing scale and geographic diversification as well as the issuer's commitment to deleveraging.
Sibanye-Stillwater is a diversified precious metals producer with exposure to platinum group metals and gold. It has an ITR and CIR well below the sector average at 1.5 °C vs 2.9 °C and 695 vs 3,381 respectively. We added the new issue given the attractive yield on offer relative to the underlying credit risk, supported by management's ongoing shift towards a more conservative and credit-friendly financial policy under the new CEO. The company is focused on strengthening the balance sheet and maintaining lower leverage through the cycle, a strategy that has already been reflected in positive rating agency outlook actions. In addition, the long-term outlook benefits from its gold exposure, with gold prices supported by both current strength and favourable structural tailwinds.Performance
The fund delivered a positive return in Q2, outperforming the benchmark as the financial markets recovered after the shock of the events in the Middle East. Outperformance primarily reflected the reversal of the previous quarter’s underperformance within our holdings – demonstrating the importance of taking a longer term view and holding positions where we have confidence in the underlying strength of the companies. We therefore saw a strong contribution from our relative underweight in A-rated issues and overweight in BBB & BB issues. In addition, corporate hybrids, an asset class we like and are overweight recovered strongly after under-performing in March. Utilities, Real Estate and Banks were the sectors that out-performed with the former two sectors having the highest holdings in corporate hybrids as well as in the case of utilities being critical to driving the transition. The strong contribution from the Banking sector was driven primarily by our security selection and in particular our holdings in UBS, Societe Generale, CommerzBank and Standard Chartered.
Q2’s strong performance was sufficient to restore a positive absolute return year to date albeit still slightly behind the benchmark. Sector allocation was broadly neutral with security selection within the Real Estate (Aroundtown & GrandCity), Banks (Societe Generale, UBS, Julius Baer & Credit Agricole), and Telecommunications (SES & Telefonica) sectors driving performance.Outlook
All in all, in the face of more geopolitical developments fixed income delivered another steady month of strong performance. Further easing of energy concerns and softer inflation data would support a more constructive backdrop for government bonds moving forward, while strong corporate fundamentals and sustained investor demand continued to underpin credit markets. Although risks remain and vigilance is still warranted, the asset class has navigated recent volatility well, leaving credit attractive from a carry perspective and the outlook for duration more balanced than at the start of the month.
SUSTAINABILITY
Five years after launch, our TargetNetZero fixed income strategies demonstrate that investors can align portfolios with climate objectives without sacrificing financial performance. Over this period, the strategies have consistently maintained a structurally lower carbon footprint than their benchmarks and an implied temperature rise below 2.0 °C while preserving diversified exposure across sectors.
A key element has been looking beyond headline emissions reductions. A portfolio's carbon footprint can decline for technical reasons, for example, when higher-emitting bonds mature or when sector allocations shift, without any real improvement in the underlying companies. A more robust approach isolates these effects and focuses only on changes driven by issuers' own emissions. This distinction is important. It shows whether decarbonisation reflects genuine progress in the real economy or simply portfolio construction. Using such a framework, evidence indicates that portfolios can achieve faster and more meaningful emissions reductions than their benchmarks when driven by active selection of companies that are credibly reducing their carbon footprint.
Progress is rarely linear. Decarbonisation pathways differ significantly across sectors, technologies and regions, creating both challenges and investment opportunities. Rather than excluding large parts of the economy, the TargetNetZero approach seeks to identify transition leaders and companies with the potential to improve, supporting a broader and more inclusive transition.
Importantly, integrating carbon and temperature considerations has not created a structural performance drag. Financial outcomes continue to be driven primarily by bottom-up credit analysis, with sustainability constraints having only a limited impact. In some cases, favouring companies better positioned for the transition can even help reduce exposure to long-term risks.
Five years on, the conclusion is clear: climate-aware fixed income investing is no longer a trade-off. With the right tools and discipline, it can deliver both measurable decarbonisation and financial outcomes, making it an integral part of long-term investment thinking.
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