Carmignac P. Credit : Letter from the Fund Managers

2022 was a terrible year for credit markets globally. No corners of the credit world were spared, with double-digit declines the norm across sub-asset classes. We were disappointed by our deeply negative absolute return and are determined to recover the lost ground for our clients going forward – more on that below. We make plenty of mistakes every year; we are fully aware that we made too many in 2022, resulting in significantly lower outperformance than in previous years. That said, given the unprecedented circumstances and the long bias (with no currency exposure) embedded in our fund’s mandate, we think our investment process has fared decently, and it has been strengthened by the lessons learned from our mistakes.

Barring Russia, we saw more improved situations than default incidents among the companies in our portfolio. The financial health of a significant number of issuers whose bonds we own picked up as a result of inflation (especially in the commodities and finance sectors). Our hedges played their role and contributed positively to our full-year return (one could argue that we should’ve hedged more but we were at the upper limit of our hedging capacity for a good part of the year). As discussed in previous quarterly reports, we misjudged how the war in Ukraine would play out, and have learned our lesson in terms of better controlling for country risk in the future. Most Russian issuers are still meeting their debt service obligations and the value of our investments there recovered in the second half. For bonds that were trading close to a conservative assessment of their fundamental value and for which there was enough market liquidity to sell, we took advantage of the opportunity to dispose of our holdings. We will continue to do so going forward.

We are excited about the performance prospects for our portfolio as we head into 2023. It currently has an adjusted yield of more than 9% along with an average BB+ rating (but beyond ratings, we believe our portfolio is made up of companies with robust fundamentals whose risks are very well remunerated). This level of carry is historically high and tilts the range of potential outcomes very much in favour of investors in our fund. Even if credit markets experience another once-in-50-year bear market for the second year in a row, our portfolio’s yield means we could withstand at least 200bp of further widening before our returns slide into negative territory. Such additional widening, whether it occurs in rates or spreads, would likely be devastating for many other asset classes (including private-market investments, which mostly didn’t reprice in line with the fundamentals in 2022 and which could be due for a catchup if the environment deteriorates further). In such a scenario, we believe our hedges and our bond-picking would allow us to outperform, as we have in every calendar year since the fund was launched. Conversely, if spreads tighten across the credit space, it’d be hard not to imagine us delivering solid double-digit returns owing to both the resulting capital appreciation and the fixed income. Attractive opportunities are to be found by staying rational when markets are driven by fear, and rarely in our careers have we seen such a good window of opportunity.

In addition to today’s favourable market climate, we’re excited about what looks like the end of more than 10 years of financial repression. Now that the major central banks are injecting less liquidity, rates and spreads should settle in at structurally higher levels. A more substantial cost of capital will cause average default rates to return to normal – and bring back meaningful alpha generation opportunities in restructuring situations along with generous risk premia. In all, we believe Carmignac Portfolio Credit has the wind in its sails and offers much greater potential for delivering solid returns and outperforming in the years to come than ever before.