Raiffeisen-ESG-Income taking advantage of significantly improved yield environment

Due to the sharp increase in yields over the past two years, the bond markets offer investors a much better risk-return ratio than was seen in the previous decade. Raiffeisen-ESG-Income has taken advantage of this and significantly increased its bond holdings as yields have risen.

By contrast, the fund was positioned very cautiously during the phase of low interest rates up until 2021 because the risk-return profile of the bond markets was unfavourable. This is a striking example of its anticyclical, valuation-oriented investment style, which is simultaneously characterised by a high level of flexibility.

In practice, this means that the fund management tends to go against the general market trend. For example, it scales back bond holdings and/or reduces the duration in the fund portfolio when bond prices are rising and makes purchases again (accepts greater interest rate risk) when prices are on the decline. However, certain conditions have to be met, the most important of which are valuations and return expectations. In other words, purchases are not automatically made when bonds or equities are falling, but rather only if they reach attractive valuations and return levels in the process.

What are potential disadvantages or risks?

Naturally, this concept also involves risks. If the fund management is incorrect in its assessment, it may make purchases too early. Generally speaking, cheap or attractive assets can always become even cheaper/more attractive. In addition, waiting for opportune times to invest by no means offers sure protection against price losses, but it does at least reduce these risks or their probability somewhat. This of course applies to the current situation, as well. Naturally, the fund management may also be overambitious and wait in vain for more favourable opportunities to enter the market. Although this would not result in any loss of value for the fund, it could lead to generally lower earnings from (missed) advantageous market movements.

Equities and bonds are promising right now

In the years marked by the low-interest environment, it was often the equities in the fund portfolio that provided the majority of the returns for the fund with their dividends and potential price gains. Dividend yields were generally much higher than bond yields during this time. This has since reversed. With a dividend yield of roughly 3.7% at the moment, the equities in the fund portfolio still offer an attractive source of returns. In light of the increases in share prices in recent months, however, the equities position is being gradually reduced. The portfolio return of the overall fund (equities and bonds) is currently around 5.5% p.a. Naturally, however, this average yield for the fund portfolio cannot be equated with the expected annual return, which can be lower or higher than this figure.

Equities segment: Focus on high-dividend shares

Because the goal of Raiffeisen-ESG-Income is to generate the most constant returns possible, the equities segment of the fund is focused on high-dividend shares. Preference is given to high-quality companies with good price-setting power, solid balance sheets, robust business models, and strong market positions. All of this supports dividend payments that will rise over the long term and are well secured. The fund management recently started building up a position in Chinese equities, which have now reached attractive valuation levels after years of marked price declines. Equities currently make up just over a quarter of the fund portfolio.

Bonds: Duration increased considerably

The fund management has gradually increased the duration over the past two years – from 1.5 years initially to a current level of roughly 5.4 years – and has also added a few bonds with very long maturities to the portfolio. These assets offer particularly high potential for price gains in the event of yield declines. If these yield declines do not come to fruition, the attractive yield will remain intact for a long period of time at any rate. At the same time, the prices of these bonds react especially negatively to potential yield increases. However, the fund management believes that substantial, lasting increases in market yields are quite unlikely at present.

High yield and Emerging Market bonds in the fund

A year ago, high yield bonds still made up a significant portion of the fund’s bond portfolio, but they have been reduced substantially since then, from around 15% in October 2022 to roughly 8% at present. Their spreads versus government bonds – and thus also the returns to be expected in the future – have dropped considerably. Conversely, Emerging Market bonds (US dollar bonds that are hedged against the currency risk versus the euro) still have a relatively high weighting in the fund portfolio.

Sentiment on the financial markets currently positive

The financial markets have priced out or pushed back the expected timing of a significant share of the interest rate cuts that had been firmly priced in for this year at the beginning of the year. However, the prospects of further declines in inflation rates and thus also interest rate cuts by the central banks are generally still intact. At the same time, equities are getting support from solid earnings developments on the whole, and potential recession fears have disappeared for the most part, at least for the next few months. However, high stock valuations in some cases – particularly in the USA – and intense geopolitical tensions and risks represent latent stress factors that could lead to market corrections at any time. All in all, this translates to a positive base scenario for equities and bonds at the moment, albeit one that harbours risks for negative developments.

By the way: Raiffeisen-ESG-Income ended the difficult year 2022 in the top quartile of its Morningstar peer group. The results for the periods over three and five years are even more interesting, as the fund ranks in the top decile of its respective peer groups.

The fund rules for Raiffeisen-ESG-Income were approved by the FMA. Raiffeisen-ESG-Income can invest more than 35% of its assets in securities and money market instruments from the following issuers: Canada, the United States of America, Japan, Australia, Germany, Finland, Belgium, Spain, Switzerland, Sweden, Great Britain, Italy, Austria, the Netherlands, and France.