MFM Global ConvertibleOpportunities

What happened
In July, bond investors remained more fearful than equity ones as usual. The latter convinced that central bankers would not reduce stimulus and raise interest rates, focusing on strong economic growth. The negative surprises came from China due to the increase in regulatory repression. The party's relentless actions against its most innovative companies remain disconcerting. While it is difficult to predict the future decisions of the Chinese Communist Party, it seems valid to remain cautious in the short term while maintaining exposure to Chinese growth assets at a strategic level.

In the convertible bonds asset class, Asia-ex was deeply hit by concerns over regulatory risks in several sectors, led by information technology, health care and real estate, losing -5.08% over the month. The US was impacted by the turmoil in Chinese markets, dropping by -1.60%, while Japan and Europe remained relatively resilient.

MFM Global Convertible Defensive (CHF-I class) returned -0.76% against its benchmark at -1.24%.
In relative terms, the outperformance came mainly from our underweight in the investment-grade universe's mastodons, Meituan (CN, consumer discretionary), suffering from Chinese regulatory risk, and EDF (FR, utilities), penalized by restructuring delayed, bringing +32bps and +24bps respectively. However, Pioneer Natural Resources (US, energy) was the main detractor as concerns on economic recovery weighed on the sector, costing us -8bps.

In the portfolio, we have actively managed our equity risk. First, we took profit in positions with high delta during the month, like Zhongsheng Group (CN, consumer discretionary) and Anta Sports (CN, consumer discretionary). Second, we switched Twitter 24s into 26s (US, communication services) and Jazz Pharmaceuticals 26s into 24s (US, health care) to take profit and improve convexity. Finally, we increased our exposure to Bharti Airtel (IN, communication services) and initiated a position in Zhejiang Expressway (CN, industrials).

MFM Global Convertible Opportunities (EUR-I class) returned -1.39% against its benchmark at -1.41%.
In absolute terms, we suffered mainly from the weakness of Chinese markets, due to regulatory risks, as well as the poor performance of US consumer discretionary, impacted indirectly by disappointing earnings of Amazon (e-commerce) and delta variant spreading (traveling related), costing us -96bps and -37bps, respectively. In relative terms, we benefited from the underweight in Novocure (US, health care) and Iqiyi (CN, communication services), bringing +9bps and +7bps respectively. However, we suffered from our "equity play" satellites in Asia-ex, Kakao (KR, communication services) and Lenovo (CN, information technology), costing us -11bps and -8bps respectively.

We took profit in "gamma play" satellite, Symrise (DE, materials). We increased our positions in Nice (IL, information technology) and Etsy (US, consumer discretionary) among “equity play” satellites. In addition, we rebalanced our "core" to maintain a genuine diversification and an optimal convexity into our portfolio, initiating Bentley Systems (US, information technology), for example.


What's next
Economic recovery will continue to be uneven across regions and sectors as Covid-19 variants spread. It will be essential to quantify the impact of the new restrictions on the service economy. Once the pandemic is contained, the economic cycle will enter a second phase marked by moderate but more synchronized growth. At the corporate level, this second quarter should mark the peak of earnings growth following last year's economic downturn. Margins are still sound. They may decline as prices rise, supply chains stay congested, and wages start to increase. In the financial markets, wage growth will be one of the most scrutinized indicators. Indeed, if wages are growing on a sustained basis, investors are likely to question the transitory nature of inflation. Moreover, a continued wage increase could turn recovery-related inflation into a self-fulfilling prophecy pushing central banks to raise rates - an armful scenario for most asset classes, even if historically convertible bonds have benefited from moderate raising rates and moderate growth environment.

We favor high credit quality, lower duration, and balanced convertible bonds in the MFM Global Convertible Defensive. Hence, the strategy profile remains defensive, and we will keep seizing opportunities in the continuously expanding convertible bonds universe.

In the MFM Global Convertible Opportunities, asides from a more diversified core, we actively manage our equity exposure to benefit from attractive entry points in Equity and Gamma satellites while participating in the primary market.