September 2025

“The kids are alright.”  Pete Townshend

And so, just like that the first three quarters of the year are done, and by all measures it’s been a solid year thus far for risk markets. European financials have been outperforming, finally reaping the benefits of a decade-long restructuring and a normalized interest rate environment after the disastrous excesses of Monetary Theory-induced money printing.  Happily, capital is finally being repatriated to shareholders, and the regulatory community seems ready to rethink some of the more onerous aspects of post-crisis changes.  And M&A is back on the table, even if few deals have been consummated.  The fact that some of the mooted transactions seem badly conceived must surely be a sign that hubris has also returned.

That both equity and credit valuations are the highest in years seems appropriate, and with very few exceptions the banking sector is in a very healthy financial position.  So, what to make of percolating fears about risks from concentrated exposures to overheated industries amid slowing growth? For example, it’s clear that almost anything AI related has attracted extraordinary investor interest and it’s fueling a massive capacity buildup.  If history is an indication, at some point capacity will run ahead of demand and anyone who’s provided financing will be vulnerable.  This has always been the case, and even if we can’t predict when the cycle will turn, leveraged exposure to mispriced assets will suffer.

Fears that the European banking system will be at the center of the next downturn are misplaced.  While there will undoubtedly be losses suffered, there simply isn’t the same exposure or the same thin layer of capital propping up vulnerable institutions.  If anything, a shock – especially if it’s a market event rather than an economic one – probably represents a buying opportunity. In that sense, the current situation is more akin to the late 1990’s than 2007/8.  So, if it’s not primarily the banks in the thick of it who will be?  Historically, the answer lies in identifying which asset class has seen the swiftest growth, and which operates outside the regulatory structures imposed on bank lending and you will probably have your answer…

Elsewhere the well-established news trends continued in September as the French political situation continued to deteriorate.  President Macron appears hell-bent on swapping more prime ministers than Liz Taylor did husbands.  At this stage, it increasingly seems that the only way out of the current mess is for the president to resign, and pressure will likely build to force that outcome.  We believe the risk premium on French assets would have further to widen if this comes to pass. If the correction is significant, it could create interesting tradeable opportunities, although our base case is that at this stage the banking system has decoupled enough from the sovereign as to be somewhat immune to anything other than extreme outcomes.

Economic data continued to drift towards slower growth and in the US, as expected, the Fed cut rates by 25bp.  What wasn’t expected was the shift in language towards concern over softer job creation, thereby leading the market to price in several more cuts.  Predictably, the bond market responded well which, increasingly puts it at odds with a stock market that is driven by a narrower and narrower cross-section of industries.  Typically, rallies getting less broad is a precursor to a top, and as we alluded to earlier, a significant correction would not be a surprise at some point soon.  It is unusual for the bond and stock markets to diverge in this manner for long.

European financials remained firm throughout the month, and we expect Q3 results will justify the performance.  This sector is not immune to the vagaries of the broader markets, but we’d reiterate that any weakness would present good opportunities rather than augur a new “Dark Ages” for banks.  For the month, the fund’s A shares were up 0.92%, with contributions of 117bp from credit and -9bp from equity on a gross basis and +15% net return for the year thus far, with annualized YTD volatility of 3.7%.  We are mindful of the fact that Sharpe Ratios of credit funds tend to peak just before market discontinuities, but in this case, it is a validation of our strategy of the past eighteen months.  With the year end ahead, we’ve continued on the same path of harvesting positions while retaining maximum flexibility to respond to adverse market conditions should they present themselves.