The super election year of 2024 lies behind us. In addition to another interest rate hike by the major central banks in the USA and Europe, it brought a potentially landmark election victory for Donald Trump in the US presidential election. What is in store for 2025?
In the Funds check series, the fund managers of selected funds look back on the developments of the past year and give their assessment of what to expect from the stock exchanges in 2025. (Please note: forecasts are no reliable indicator of future performance.)
(c) Photo: Stephan Huger
"After strong growth rates in new issues in previous years, the European hybrid market was characterised by consolidation in 2024.”
Roman Swaton, Fund manager ERSTE BOND CORPORATE PLUS
Fund & Performance
ERSTE BOND CORPORATE PLUS mainly invests in subordinated bonds with an investment grade rating. The focus is on hybrid bonds denominated in euros from the non-financial sector. Subordinated emissions from financial institutions are added.
Note: Please note that an investment in securities entails risks in addition to the opportunities described. Past performance is not a reliable indicator of future performance.
Performance since start of the fund (12.12.2016). The performance is calculated in accordance with the OeKB method. The management fee as well as any performance-related remuneration is already included. The issue premium which might be applicable on purchase and as well as any individual transaction specific costs or ongoing costs that reduce earnings (e.g. account- and deposit fees) have not been taken into account in this presentation.
Commentary by fund manager Roman Swaton
How did the fund perform in 2024?
Thanks to the decline in yields on German government bonds, particularly at the short end of the market, over the first eleven months of 2024 and the narrowing of credit spreads on hybrid corporate bonds as well as subordinated bank bonds and insurance bonds relative to the beginning of the year, the fund achieved a performance of +7.6% in 2024.
The main drivers behind the decline in yields on German government bonds were the three key-lending rate cuts by the ECB – 0.25% each – to 3.25% (deposit facility). After an inflation rate in the Eurozone of over 8% in 2022, the rate had fallen to just over 2% by the end of 2024 and should remain there in 2025. Despite the gloomy economic outlook in 2024, companies with good credit ratings in the Eurozone experienced an increase in cash and cash equivalents and sales as well as stable debt ratios and operating margins at least until the third quarter of 2024, which was also recognised by the rating agencies in the form of a positive rating drift – i.e. more upgrades than downgrades over the past two quarters.
Thanks to generally strong inflows into investment-grade bond funds, credit spread volatility remained mostly subdued in 2024. In the real estate sector, which suffered particularly from the sharp interest rate hikes in 2022 and 2023, spreads also fell significantly in 2024, as a result of which here, too, yields are again trading at their first call date (“yield to call”).
After strong growth rates in new issues in previous years, the European hybrid market was characterised by consolidation in 2024. The real estate sector had to overcome the challenge of high interest rates. While from 2018 to 2021, issuing activity in the real estate sector was still vigorous, the higher financing costs after 2022/23 from an issuer’s perspective made the equity component of hybrid bonds more expensive compared to shares across all sectors.
What was the focus of the fund in 2024?
In the ERSTE BOND CORPORATE PLUS fund, we strategically add bank and insurance bonds totalling 35% to corporate bonds (non-financials) for diversification reasons. This is because four of the 15 largest hybrid issuers (Total, Repsol, Enel, and ENBW) are not investable for ESG reasons. British American Tobacco exited in 2024 for the same reason. VW, on the other hand, became investable again. Three issuers (EDF, Vodafone, Telefonica) may no longer be actively purchased because the second-best rating of their subordinated issues is already in the BB range (their senior rating is in the good to very good range). (Please note: the companies listed here have been selected as examples and do not constitute an investment recommendation.)
Germany (VW, Merck, Aroundtown, Deutsche Bahn, Hannover Re, Munich Re) now accounts for the largest country weight, followed by Spain (Iberdrola, Banco Bilbao, Banco Santander). We reduced French issuers in light of the potential downgrade of France, meaning that France is now only the third-largest country weight; in 2023, it was still the largest.
The energy, telecommunications, and utilities sectors are overweighted, while the automotive sector, insurance, and consumer goods are underweighted. The underweight in the real estate sector was turned into a slight overweight.
The average rating of the fund at BBB does not differ from the peer group. The average ESGenius® score (= the proprietary sustainability score of Erste Asset Management) is 65, slightly higher than that of the investable universe.
What are your expectations for the financial markets in 2025?
We expect that most companies will continue to pursue a call-and-replace strategy in 2025 in order to avoid losing the equity credit from hybrids by S&P. For regular issuers with liquid balance sheet items, there are strong incentives to refinance hybrid bonds even at higher yields. On top of that, the market should remain technically well supported. The pool of potential first-time issuers of hybrid capital is shrinking. 13% of European companies with outstanding senior bonds (= senior bonds that are treated preferentially in the event of insolvency) have already issued hybrid bonds. However, these are the larger issuers, who account for about a third of all senior capital market debt.
Compared to government bond yields, hybrid bonds may no longer look as attractive in historical terms, but they still benefit from the yield buyer. The yield as of 31 December 2024 was 4.12%.
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