Henrik Stille, Manager of Nordea’s European Covered Bond Strategies

As we approach the end of 2024, the economic outlook remains uncertain, with debates around whether the global economy is heading for a soft or hard landing. Amidst this uncertainty, one asset class stands out as a beacon of stability and potential performance: Covered Bonds. These instruments, long recognized for their safety and reliability, are poised to outperform European Investment Grade (IG) Corporates and government debt, making them an attractive option for investors seeking both security and returns in a volatile market.

The Enduring Appeal of Covered Bonds

Covered Bonds have a storied history spanning over 200 years, with not a single default recorded in that time. This remarkable track record is a testament to their safety and low-risk profile. As of 2022, the market for Covered Bonds was substantial, with approximately EUR 3 trillion outstanding, primarily issued by countries like Denmark, Germany, France, Spain, and Sweden.¹

These bonds are characterized by their “dual-recourse” nature, meaning they are backed by both the issuing institution and a cover pool of assets, such as mortgage loans or public sector debt. This dual backing, coupled with stringent local legislation, low Loan-to-Value (LTV) requirements, and active management of the cover pool, ensures that these bonds remain highly secure. Furthermore, European regulations, particularly under the Bank Recovery and Resolution Directive (BRRD), have exempted Covered Bonds from bail-in procedures, adding another layer of safety for investors.

Market Dynamics in 2024

The first half of 2024 saw a reduction in new Covered Bond issuance, following a record high in 2023. This decline was anticipated, as mortgage activity slowed across Europe. The decreased supply contributed to a tightening of spreads, with Covered Bonds seeing a 13 basis point improvement by the end of May 2024. However, market volatility reared its head in June when French President Emmanuel Macron’s unexpected call for snap elections sent shockwaves through the markets. This uncertainty, coupled with concerns about fiscal policies in countries like France, Italy, and Belgium, led to a widening of spreads in both government and Covered Bonds. Nevertheless, despite this volatility, the inherent safety of Covered Bonds positions them as an attractive entry point for investors, especially when compared to the more volatile IG corporate bonds.

Investment Case: Covered Bonds vs. IG Corporates

The recent widening of spreads in Covered Bonds, contrasted with the tightening spreads in IG Corporates, presents a compelling investment opportunity. Historically, the spread between corporates and Covered Bonds has hovered around 100 basis points, but as of mid-2024, this pick-up has narrowed to approximately 40 basis points. This presents a rare opportunity for investors to enter the Covered Bond market at attractive levels.

Looking ahead, we anticipate a continued decline in Covered Bond issuance due to reduced mortgage activity. In contrast, IG corporates, which are currently priced optimistically for a soft landing, may face more significant challenges in a choppy economic environment. Covered Bonds, with their conservative nature, are expected to perform at least in line with corporates, if not better, offering more protection and higher risk-adjusted returns.

Investment Case: Covered Bonds vs. EU Government Bonds

Covered Bonds are often seen as a substitute for EU government debt, given their defensive and high-quality nature. The supply dynamics in 2024 further bolster the case for Covered Bonds. While the net supply of EU government debt is expected to increase due to ongoing budget deficits, the issuance of Covered Bonds is likely to remain subdued. This imbalance in supply supports the performance of Covered Bonds relative to government debt.

In the second half of 2024, we expect Covered Bonds to continue offering solid protection in risk-off environments, with better-expected returns compared to government debt. In our view, active management in this space can further enhance returns, leveraging opportunities in a market where the supply-demand dynamics are favorable.

In conclusion, 2024 presents a potentially unprecedented opportunity to invest in Covered Bonds. As an asset class, they offer an attractive allocation within strategic asset allocation, particularly for risk-averse investors looking to diversify away from corporates. With comparable returns at lower risk levels, we believe Covered Bonds stand out as a compelling choice in the current market environment.

Nordea Asset Management’s (NAM) Value Proposition in Covered Bonds

NAM stands as a leading player in the Covered Bond market, managing around EUR 40 billion in this asset class. With a seasoned team of portfolio managers boasting an average of 20 years of experience, we have consistently demonstrated its ability to generate alpha potential in this space. Unlike passive strategies, our active management approach takes full advantage of the inefficiencies and nuances within the Covered Bond market, such as issuer premiums and rating methodology discrepancies.

With our proven track record and deep expertise in Covered Bonds, NAM is well-positioned to help investors navigate this complex market, seeking to deliver attractive risk-adjusted returns in 2024 and beyond.

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The performance represented is historical; past performance is not a reliable indicator of future results and investors may not recover the full amount invested. The value of your investment can go up and down, and you could lose some or all of your invested money.

Covered bond risk: Covered bonds are bonds usually issued by financial institutions, backed by a pool of assets (typically, but not exclusively, mortgages and public sector debt) that secure or “cover” the bond if the issuer becomes insolvent. With covered bonds the assets being used as collateral remain on the issuer’s balance sheet, giving bondholders additional recourse against the issuer in case of default. In addition to carrying credit, default and interest rate risks, covered bonds could face the risk that the collateral set aside to secure bond principal could decline in value. 

About Nordea Asset Management
Nordea Asset Management (NAM, AuM 264bn EUR*), is part of the Nordea Group, the largest financial services group in the Nordic region (AuM 400bn EUR*). NAM offers European and global investors exposure to a broad set of investment funds. We serve a wide range of clients and distributors which include banks, asset managers, independent financial advisors and insurance companies.

Nordea Asset Management has a presence in Bonn, Brussels, Copenhagen, Frankfurt, Helsinki, Lisbon, London, Luxembourg, Madrid, Milan, New York, Oslo, Paris, Santiago de Chile, Singapore, Stockholm, Vienna and Zurich. Nordea’s local presence goes hand in hand with the objective of being accessible and offering the best service to clients.

Nordea’s success is based on a sustainable and unique multi-boutique approach that combines the expertise of specialised internal boutiques with exclusive external competences allowing us to deliver alpha in a stable way for the benefit of our clients. NAM solutions cover all asset classes from fixed income and equity to multi asset solutions, and manage local and European as well as US, global and emerging market products.

Having entered the ESG space over 30 years ago, Responsible Investment is deeply rooted in our Nordic DNA. As an ESG pioneer and market leader we established an award-winning RI Team in 2009—now one of the largest in Europe. We currently offer a broad suite of RI solutions to investors of all types across the globe.

* Source: Nordea Investment Funds S.A.,30.06.2024

Nordea Asset Management is the functional name of the asset management business conducted by the legal entities Nordea Investment Funds S.A. and Nordea Investment Management AB and their branches and subsidiaries. This material is intended to provide the reader with information on Nordea Asset Management specific capabilities, general market activity or industry trends and is not intended to be relied upon as a forecast or research. This material, or any views or opinions expressed herein, does not amount to an investment advice nor does it constitute a recommendation to buy, sell or invest in any financial product, investment structure or instrument, to enter into or unwind any transaction or to participate in any particular trading strategy. Unless otherwise stated, all views expressed are those Nordea Asset Management. Views and opinions reflect the current economic market conditions, and are subject to change. Any investment decision should be based on the Offering Memorandum or any similar contractual arrangement. All investments involve risks; losses may be made. While the information herein is considered to be correct, no representation or warranty can be given on the ultimate accuracy or completeness of such information. Prospective investors or counterparties should discuss with their professional tax, legal, accounting and other adviser(s) with regards to the potential effect of any investment that they may enter into, including the possible risks and benefits of such investment, and independently evaluate the tax implications, suitability and appropriateness of such potential investments. Published by the relevant Nordea Asset Management entity. Nordea Investment Management AB and Nordea Investment Funds S.A. are licensed and supervised by the Financial Supervisory Authority in Sweden and Luxembourg respectively. This material may not be reproduced or circulated without prior permission. © Nordea Asset Management.