LO Funds (CH)
Swiss Franc Credit Bond

MACRO AND MARKET REVIEW

Despite a move higher in interest rates, strong credit performance saw fixed income markets broadly flat at an aggregate level for August, as the appetite for carry remained robust. Thirty-year Treasury yields briefly rose above 5.3%, their highest level since 2007, while long-dated French and German government bond yields reached levels not seen since the sovereign debt crisis. Markets became increasingly concerned that a combination of persistent inflation, large fiscal deficits and rising term premia would keep long-term borrowing costs elevated. Credit markets remained relatively resilient, supported by another quarter of strong corporate fundamentals, although higher rates volatility weighed on parts of the lower quality credit universe.

The geopolitical backdrop remained dominated by the continuing conflict between the US and Iran. Periodic military exchanges and continued disagreement over access to the Strait of Hormuz maintained a high degree of uncertainty for global energy markets, with a move towards tit-for-tat tanker strikes a particular concern. Officially observed shipping volumes through the Strait remained well below pre-conflict levels, but with many vessels continuing to rely on alternative routes or operating with limited visibility, oil price moves have been orderly. However the bigger issue lies in refined products, most notably diesel, and natural gas markets. These have continued to rise and now sit above March highs. Their feedthrough into inflation figures over the winter period requires close attention.

US macro data provided somewhat mixed signals for markets. Inflation remained above the Federal Reserve's 2% target, with July Personal Consumption Expenditures (PCE) inflation running at 3.7%, while higher energy prices continued to present upside risks. However signs of a slowing, or at least stagnant, labour market paint a contrasting picture. This has led to a stark fragmentation in the Federal Open Market Committee (FOMC), with several policymakers arguing that policy was not sufficiently restrictive, while others highlighted signs of slowing growth. That said, Chair Warsh's Jackson Hole speech was interpreted on the more hawkish side, stressing that inflation progress remained inadequate and reinforcing expectations that additional tightening could still be required if price pressures failed to moderate further, putting the September decision into sharp focus.

Against this backdrop, another development saw Treasury Secretary Scott Bessent unveil proposals to support the Treasury market through expanded buybacks of longer-dated debt financed by increased short-term issuance. The announcement sparked a short-term rally in long-dated Treasuries and prompted speculation that the Treasury could further reduce long-end issuance later in the year. Although the initial rally in treasuries was sharp, many market participants remained sceptical that technical interventions alone could deliver a sustained decline in yields without clearer evidence of cooling inflation and slower economic activity, ultimately causing the rally to be short-lived.

European developments mirrored many of the themes seen in the US. Hawkish comments from several Governing Council members reinforced the view that inflation risks, particularly those linked to energy prices, remained a concern despite slowing economic momentum. France remained a focal point for investors, with concerns around fiscal credibility contributing to underperformance in long-dated French government bonds with next year's elections coming onto investors’ horizons. While some ECB officials cautioned against overtightening in response to what remains partly a supply-driven shock, markets entered September expecting at least one further increase in policy rates this year.

In Switzerland, over the course of the month, indicators such as PMI, KOF and GDP have confirmed a brightening picture for growth. Despite this, Swiss fixed income remained largely insulated from the global rates sell-off during August, with ten-year government bond yields ending the month at around 0.44% — barely changed — in stark contrast to the sharp moves seen in US Treasuries and core European government bonds. The franc softened modestly against the euro over the month, with the Swiss National Bank (SNB) reiterating its willingness to intervene in foreign exchange markets if necessary, providing a partial ceiling on appreciation pressure. Switzerland's low-yield, low-volatility fixed income market continued to offer relative stability for investors navigating a turbulent global duration environment.

PORTFOLIO ACTIVITY

In the CHF-denominated primary market, we participated in the new issues of Deutsche Bank (DB) and UBS Group (UBS). In the CHF secondary market, we added Banco Santander (SANTAN) and Nordea Bank (NDAFH). We also sold some of our positions held in Luzerner Kantonalbank (KBLUZE) and Clariant (CLNVX).

In the foreign currency primary market, we participated in the new issue of Sika (SIKASW). In the secondary segment, we added some Public Property Investments (PUPRIN), La Poste (FRPTT) and Mobico (MCGLN). We sold some of our positions held in Heimstaden Bostad (HEIBOS) and Telenet (TNETBB).

In terms of sector allocation, we are mainly overweight in Real Estate, Banking & Financials Subordinated and Insurance Subordinated, while underweight in Banking & Financial Services CHF Seniors and Communications & Technology CHF.

PERFORMANCE

In August, the CHF government bond yield curve steepened, with yields at the short end and in the belly declining slightly, while yields at the long end rose modestly. Over the same period, CHF credit spreads widened slightly across all rating categories (+1 bps). From a sector perspective, Industrials marginally outperformed on a spread basis, remaining unchanged, while Financials and Utilities widened slightly (+1 bps).

As a result, the total return of both LOF (CH) – Swiss Franc Credit Bond and its benchmark, the SBI® A-BBB, was positive, driven primarily by credit carry and, to a lesser extent, by the positive contribution from lower yields at the short end and in the belly of the curve. In this environment, the Fund generated positive relative performance. This was primarily driven by effective sector allocation and robust security selection. At the sector level, the Fund's overweights in the Communications and REITs sectors contributed positively to relative performance. Conversely, both systematic and discretionary credit hedging strategies detracted from performance, reflecting the tightening in credit spreads in EUR and USD credit markets during the month. YTD, both absolute and relative returns of the LO Funds (CH) – Swiss Franc Credit Bond Fund are in positive territory on a gross-of-fees basis.

OUTLOOK

Overall, August highlighted the challenges facing fixed income markets as investors balanced persistent rates pressures against strong fundamentals and a clamour for attractive carry opportunities in credit. Geopolitical uncertainty, elevated government borrowing requirements and increasingly hawkish central bank rhetoric combined to create a difficult environment for duration. Nonetheless, yields across many developed markets have reached levels that increasingly compensate investors for these risks, while high-quality fixed income continues to offer attractive income opportunities.