Implications of the Credit Suisse takeover

The takeover of Credit Suisse by UBS over the weekend caps a turbulent few years for the bank.

We had been monitoring developments closely over recent months and were willing to give the benefit of the doubt to the attempts of Credit Suisse’s management team to turn-around the business. To this end we participated in a Senior bond issue last November which formed part of the bank’s restructuring plan. We felt the downside was limited as in a worst-case scenario the Swiss authorities would likely step in because of the significance of the bank both globally and domestically.

However the recent failure of three smaller US banks and the resultant decline in confidence across global financial markets proved too much of a headwind for Credit Suisse to deal with, as investors and depositors took flight. Under the terms of the UBS takeover deal, most of the outstanding Credit Suisse debt has been taken on by UBS as part of the new combined entity, and at the time of writing our bond holdings are trading at their highest prices since issue.

The terms of the takeover are such that the Credit Suisse shareholders believe that their ownership rights have been overridden, whilst disaffected bondholders are aggrieved because their Contingent Convertible, or ‘AT1’, bonds have been written down to zero, and therefore treated as ranking below equity, directly contradicting usual capital structure convention. Both these actions are likely to face legal challenges in the coming months.

Having studied the terms of the deal we were unsurprised to see the outstanding bank bonds market, and especially the AT1 sector, sell-off sharply at the Monday morning open as investors feared that a new precedent had been set for the treatment of bonds in any further bank failures. Inevitably, in our view, both the EU and UK regulators then released statements to indicate that they would respect the conventional capital priority order, which led to a recovery in the market.

While sentiment remains fragile, it is important to highlight that Credit Suisse remained well capitalised while all this was playing out, and there have been no indications of any significant credit-related issues. This was a crisis of confidence in the ability of the bank to restructure its business model. With this in mind, we believe this episode was unique, and not a signal of a systemic problem for the global banking system. Any comparisons to 2008’s global financial crisis are wide of the mark, and we continue to believe that the global banking system is in far better shape to contend with future market and economic developments.

Despite the recent decline in yields, government bonds still offer the potential for some modest capital appreciation over the rest of the year if inflationary pressures can be brought to heel. The additional yield on offer from relatively attractive credit spreads, on corporate bonds, means that investors are being paid a reasonable all-in yield to compensate for any further short-term weakness. A return to more historically normal investment valuations means that bonds can now offer the prospect of fulfilling their traditional role in a diversified portfolio, as recent high correlations between asset classes begin to decline.

We continue to believe that a strategic overweight position in a diversified portfolio of good quality corporate bonds, held through the economic cycle, will produce solid risk-adjusted outperformance over our investment horizon. Although short-term periods of underperformance, as markets adjust, are an inevitable feature of our cautious, long-term approach to bond investment, we are confident that the current valuations in credit markets offer an attractive entry point, for long-term investors.

Risk Warnings                                                                                                                   

Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds. Our funds invest for the long-term and may not be appropriate for investors who plan to take money out within five years. The Fund has exposure to bonds, the prices of which will be impacted by factors including; changes in interest rates, inflation expectations and perceived credit quality. When interest rates rise, bond values generally fall. This risk is generally greater for longer term bonds and for bonds with perceived lower credit quality. The Fund invests in other currencies. Changes in exchange rates will therefore affect the value of your investment. In certain market conditions some assets may be less predictable than usual. This may make it harder to sell at a desired price and/or in a timely manner. In extreme market conditions redemptions in the underlying funds or the Fund itself may be deferred or suspended. The insolvency of any institution providing services, such as safekeeping of assets or holding investments with returns linked to financial contracts (known as derivatives), may expose the Fund to financial loss. The Fund may enter into various financial contracts (known as derivatives) in an attempt to protect the value of the Fund’s assets or to reduce the costs of investing, although this may not be achieved.

Regulatory Information 

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