Friday July 22nd, 2016
- For the YTD period ending June 30, 2016, the Energy Credit Opportunities Income Fund provided a very healthy +8.14% gross return. This return lagged the Merrill Lynch Energy Index, which returned +21.63%. The cumulative gross return since inception for the Fund is -11.82%, vs. -12.13% for the benchmark. Returns for the YTD period were driven by lower quality CCC and other marginal credits that rebounded very strongly post the mid-February lows. As recessionary fears have abated and oil prices rallied, we have seen risk assets respond accordingly.
- Despite the rally in marginal energy credits, we still believe that many of the credits in the high yield energy market are not viable and will continue to struggle with oil prices remaining in the $40-60 / barrel range. We continue to believe that the market is assuming a clearing price for oil in this range as demand continues to grow and the low prices have begun to squeeze production. Rig counts have dropped steadily from their peak and many capital expenditure projects have been shelved as they are not economically viable with prices at these levels.
- We continue to believe that the best way to take advantage of the wide spreads and high yields in the US Energy credit market is through security selection. Many of the issues that have rebounded from February 2016 lows still remain impaired and or distressed. It is likely that if oil prices remain stable in this range, these companies will eventually run out of cash. The recent rebound is not sustainable for marginal credits.
This quarter, concerns over Brexit and uncertainty over the Federal Reserve’s interest rate policy outlook dominated global markets. The risk of potential events kept investors in a holding pattern ahead of the vote, prompting trading activity to move sideways in the months leading up to the U.K. referendum. The eventual decision to “leave” shocked the markets, which largely anticipated a “stay” vote in the preceding days. As a result, growth expectations for the Eurozone were lowered and the British Pound plunged as bond yields sank to multi-year lows. It also paved the way for possible additional exits from member countries which would exacerbate uncertainty for years to come.
In the U.S., the Feds’ path for another rate hike was shrouded in uncertainty. Therefore, the market had been priced in anticipation of multiple rate hikes this year. However, data that showed slowing employment, sluggish global growth and deflationary price pressures prompted Federal Reserve Chairman Janet Yellen to revert to a dovish stance.
Meanwhile, central banks in Europe and Japan initiated negative interest rate policies which accelerated a global hunt for assets with higher yields. The Canadian economy saw some slight upside surprises to GDP and jobs data. However, concerns over a housing bubble, and the expected drag to growth resulting from the Alberta wildfires in June dampened the country’s economic outlook for the remainder of the year.
Commodities rallied in general. Oil pushed through the $50 a barrel mark as supply and demand continued to adjust. Gold surged higher on safe haven flows and as a store of wealth in a negative yielding environment. Grains, specifically soybeans and corn, rallied as bad weather across South America and the U.S. negatively impacted the supply outlook.