Fairtree Global Flexible Income Plus Fund Q3 2025 Commentary

Market dynamics

Global risk

The bull market which started at the beginning of the second quarter continued unabated into the third quarter of 2025 with North American equities rallying strongly. The large cap Dow Jones Industrial Average delivered 5.67% to investors whilst the broader S&P 500 outshone that, producing a rather pleasing 8.11%. But the star of the show yet again was the tech heavy NASDAQ which increased its value by some 11.43% in the 14th best showing since Q2 2007. When one considers that this index was actually down some 10.26% after the first quarter, the recovery of this index to its current + 17.96% on a year-to-date basis is nothing short of remarkable. If we consider that over the last two quarters the NASDAQ has delivered some 31.45%, one starts to realise the risk of not being invested in risk. The combination of the second and third quarters of 2025 is the 4th best rolling 6 month performance of the NASDAQ since Q2 2007. The best performing rolling 6 month period occurred post the COVID announcement and occurred in Q2-Q3 2020 when the world was in strict lockdown, i.e. masks, social distancing, no visitors or excessive exercising, no driving cars and a whole lot of other Orwellian measures. During this period investors in the NASDAQ witnessed some 45.65% increase in the market value of their assets. One could surmise that the ex-post posit of probability of these excessive returns during that period, was a rounding error from zero. The most recent 6 month period, post the introduction of “Global War on Tariffs”, would also have surprised the risk bears out there in that the more recent outsized returns would also have been deemed equally unlikely. But unfortunately (or fortunately) financial markets don’t really conform to “obvious” forecasts, in fact it is seldom that the NASDAQ has delivered a negative return over a 6 month period. Over the last 73 rolling 6 month periods only 19, or 26%, of them produced a negative return. That infers that 74% produced positive returns, or it was almost 3 times more likely to produce a positive rather than negative outcome. Investing certainly comes with risk, but perhaps in concentrating on the risk side of investing leads us to avoid the positive outcomes of remaining invested, and this seems to also be the case in the short run.

Table 1 below shows the ranked performance of the popular risk indices. The rankings are over the last 74 quarters and highlights the broad based rally across the globe. It was only the Dax which delivered a red number whilst the other indices were comfortably in the black. Even the FTSE 100 delivered 7.51% or the 11th best quarter since Q2 2007.

Table 1: Major Index Q3 2025 Total Return and historic rankings Q2 2007 – Q3 2025

Source: Bloomberg 30 September 2025.

Moving to European credit, the iTraxx suite of indices produced another set of numbers that were quite meaningful. The iTraxx Crossover 5 year Total Return Index produced another good quarter, posting 2.34% which outperformed European cash quite comfortably. Our more favoured 2 times levered index, a more realistic measure of the risk adjusted relative performance of European credit, produced a healthy 4.20% for the quarter. We have consistently stated that in the absence of meaningful defaults, the iTraxx Crossover suite remains a good compromise of risk and available returns and feel that the index on a levered basis should offer a better risk adjusted opportunity to investors that are willing to accept excess premium to insure company credit. This aversion to catastrophic loss is probably the main driver of the very excess returns that the indices have produced since inception. One could suggest that the return to normality might undo this excess return but our view is that the average investor has little to no appetite for taking such risk. This play ensures that risk premium remains elevated and is the very reason for the persistence of this excess return through time.

Given the fact that we have over 18 years of quarterly data, we can do more than just look at the outright performance numbers as well as the relative rankings. We can also have a look at relative risk measures such as standard deviations, Sharpe Ratios and other measures of risk adjusted returns. Obviously this should be important to investors who do “feel” risk in the diffusion of the performance that they have been delivered. For the same absolute return in a portfolio, only a fool would be happy with more risk for that return than less risk. There are many definitions of what risk is, and what is important for one investor is quite different from another, but we feel that the most consistent, and comparable, is the time tested standard deviation which has its roots in its underlying mathematical construct. This makes it totally consistent in its treatment of any distribution of potential outcomes. The simple calculation of mean divided by standard deviation gives a good measure of risk adjusted return and is one that we tend to like to look at. This is not the Sharpe Ratio (SR), as the SR strips out risk free return as well as the volatility of that risk free return, but we feel that the basic return per unit risk ratio is a good proxy for the slightly more rigorous SR. Obviously a higher number is better as the investor receives more return for his accumulated risk. We must be aware however that a high number on its own cannot be viewed as the “Holy Grail’ since any low volatility index might deliver high levels of Return Co-efficient but might not deliver that much by the way of return. By the way of an example, it might be foolish to buy an index that produces 0.4% annual return with 0.2% annualised volatility – a return co-efficient of 2, rather than an index that produces 12% return with a standard deviation of 8%.

Table 2 shows the annualised returns, the annualised risk as well as the return coefficients for the major indices that we monitor. The so called return coefficient is simply the annualised return since Q2 2007 divided by the realised annualised standard deviation of quarterly returns over that same time period. It differs from Sharpe Ratio in that the Return Coefficient does not take into account prevailing short rates in the prevailing currency, and therefore is not a measure of “excess return” but rather total return.

From a European perspective, Table 2 highlights the outperformance of credit from a risk adjusted perspective. In fact the more risk normalised two times levered index solidly outperforms its equity equivalent, offering investors excess return for a given risk target. If an investor is comfortable with equity type risk he/she should be more than happy with the extra return that iTraxx*2 has offered. This index goes a long way to close the relative risk adjusted gap to US equities. It is also important to note that these numbers are all based in local currency and do not necessarily reflect the experience of an investor from a specific domicillium. Arguably a dynamic currency hedging regime, to mitigate currency affects should do nothing to realised risk but should have an effect on the annualised return numbers, as currency hedging programs are effectively cross currency interest rate swaps ie float-float swap. This could be modelled as the integral of the differences in short rates over the period in question. 

Table 2: Index Risk Adjusted Return Co-efficient

Source: Bloomberg 30 September 2025.

As an extension of the last quarter’s report Figure 1 below, shows the cumulative return of the various indices in the currency of the particular index domicile. The various performance traces have been indexed to 100 at the beginning of the second quarter 2007, when we have the complete historic data for the iTraxx XOver, and Main total returns.

When looking at Figure1, it also becomes apparent that there are no returns to risk free. The worst performing traces over the 18.5 years is the iTraxx Main Index (125 equally weighted global investment grade credit names) and the US Treasuries total return index. Looking at the delivered risk it becomes apparent at US Treasuries are not the least risk asset class but rather the well diversified investment grade CDS index – iTraxx Main. They have generated the lowest returns coupled with the lowest associated risk over the past 18.5 years.

Figure 1: Major Index Total Return Q2 2007 – Q3 2025

Source: Bloomberg 30 September 2025.

It is difficult to look at the returns and the associated volatility of those returns simultaneously in Figure 1. To disentangle the graphic and the more meaningful comparatives, we produce the delivered risk (as computed by the annualised standard deviation of quarterly returns) as well as the delivered annualised return over the 18.5 years. This is shown in Figure 2. If we were to fit a straight line to this dataset we would observe an upward slope indicating that there is a positive return to risk. Increase that risk and it should result in a higher delivered return. The corollary of this is also apparent, a reduction in risk taken will result in a reduced overall delivered return. The textbooks, which have always stated that there needs to be an excess return to risk are indeed correct.

It remains obvious that the short run (each quarter) is deemed to be random whilst the longer run will yield excess return due to the extraction of the various risk premia, as time elapses the risk premium (or positive slope) becomes more apparent. Investors that extrapolate the short term lines do so at their peril in that to presume that the NASDAQ can continually produce +11% per quarter should result in disappointment. It is however interesting to note that the aforementioned NASDAQ does seem to adapt to the ever changing economic environment more quickly than more mainstream industrial indices, such as the Dow Jones and that North American equity indices seem more adaptable than their European and UK equivalents. This might be due to the underlying economic landscape in which those indices operate on. One might posit that the US is more “geared” to growth, and legislation in the US is more market friendly. One might argue that the social/capital balancing point is slightly more skewed to the capital side of the economic see-saw. We feel that this has even further ramification across company balance sheets in that the favourable dynamics to capital will also influence the risk reward dynamics within companies themselves. Favourable equity conditions are bad for the debt portion of company balance sheets. This is one of the main reasons why our credit fund suite remains overweight European credit, whilst underweight North American credit.

Arguably FX effects are ignored, but we strongly believe that FX risks and rewards should be fully hedged in a credit portfolio as the risk of that FX dominates the risk of the index that one is trying to mirror or enhance.

Figure 2: Major Index Risk Return scatterplot Q2 2007 – Q3 2025

Source: Bloomberg 30 September 2025.

The domination in return terms of US equities, which was touched on earlier on in this piece, is quite apparent in the figure, but one must be cognizant of the fact that these indices are shown in local currency. This explains the relatively good performance of the South African Top40 Total Return index which is based in Rand. In order to do a proper comparative study we need to translate all the indices into common currency and there the comparative becomes more meaningful.

Moving to the economic backdrop, Figure 3 shows inflation in the developed world (US, UK and Eurozone) highlighting the fact that inflation is well off its highs hit in the 4th quarter of 2022. The fact that the disinflationary trend, which started in the US, seems to have slowed down and even tacitly reversed a tad, has resulted in a more cautious response from the central banks. The European Central Bank has essentially completed its interest rate cutting cycle, whilst the Bank of England’s position is looking rather tenuous. UK CPI at 3.8% is way off the implicit 2% target of the Bank of England and the bank has effectively run out of room to manoeuvre on short rates. Unless this inflation trend reverses we might even see interest rate hikes in the UK over the short run. After the prolonged spat between the Federal Reserve and the US President, the Fed cut interest rates for the first time in 2020 during the 3rd quarter. We remain largely bullish on the potential for more cuts from the Fed before bottoming somewhere in the 3.50 – 3.75% context.

Figure 3: Annual change in Consumer Price Indices March 2010 – September 2025

Source: Bloomberg 30 September 2025.

Figure 4 below shows the level of short rates as administered by the US Federal Reserve, the European Central Bank, the Bank of England and the South African Reserve Bank. What is of interest to note is the high levels of correlation in both the direction as well as the extent of policy movements which is of no surprise given the extensive trade between these countries.

Figure 4: Central Bank Administered Rates

Source: Bloomberg 30 September 2025.

The movements in global bond yields are shown in Figure 5. The 10 year US Treasury, the UK Gilt and the benchmark European Bund are shown in the Figure albeit using 2 different scales. It is interesting to point out the high levels of correlation between these 3 traces and that although short term disconnects tend to take place, they generally are swiftly reversed.

Figure 5: 10 year benchmark yields in US,UK and the Eurozone

Source: Bloomberg 30 September 2025.

Fund Performance

The strategy of the fund is to provide investors access to a well-diversified credit portfolio that aims to outperform its targeted benchmark iTraxx Crossover Total Return Index on an after fees basis over the longer run. We have no control over the performance of the benchmark, and assume that all investors are aware of the risk/reward prognosis of that index.

Table 3 shows the total performance of the Fairtree Global Flexible Income Plus Fund (Class A) relative to iTraxx XOver, iTraxx Main and the Barclays 3 month Euribor Index over various historic periods. It should be noted that the returns are net of full fees and those full fees of Class A are 0.97% per annum. It is interesting to note that, although the short term performance numbers have turned in the 3rd quarter but the YTD 2025 and YoY numbers are still lagging the benchmark on an after full fees basis.

Table 3: Fairtree Global Flexible Income Plus Fund (Class A) historic annualised total returns to end Q3 2025

Source: Bloomberg 30 September 2025

A few things become quite apparent, and even a touch startling, when analysing the table.

1. The fund had a rather pleasing third quarter of 2025 generating 2.63% on an outright basis, outperforming the benchmark by around 0.29% and outperforming cash by 2.11% on an after all fees basis.
2. The fund has delivered in high returns over the past 3 years due to the commencement of the credit bull market as at the end of Q3 2022.
3. The fund, despite its defensive positioning has outperformed cash by around 4.53% on the most recent rolling 1 year basis
4. The fund underperformed its benchmark by 1.31% over the last rolling 12 months due to running a low risk bias

Looking to the 4th quarter of 2025, the increase in fund beta during the 3rd quarter has positioned the fund in a more normalised risk basis. Although credit spreads have narrowed again during the 3rd quarter, the managers increased risk into weakness and are now running a closer to benchmark position. The managers remain caught between a range bound market and a lower interest rate environment which may persist for the short run. Obviously it remains important during this juncture to seek out any yield harvesting potential opportunities but the negative theta position surrounding any risk short leaves the fund exposed to a slow burn relative to the index. In this regard the managers risked up and will look to any sell off to increase risk again, albeit on a selective basis. We feel that those opportunities will surface soon and the ample liquidity of the fund aids the managers in being able to tactically increase the beta of the fund into any sell off. The current spread of the fund is around 317 bps to 3 month EURIBOR on a pre fees basis, which needs to be taken up by another 50 bps or so to match the index performance post fees. This might be challenging but the managers remain confident that the fund spread at the end of the 4th quarter should be at around 100 bps pre fees.

Looking at the portfolio positioning, the fund again upped risk during the last quarter and the fund is structured for a continuation of the credit bull run that started quite some time ago. We don’t see any evidence of any impending risk-off sentiment although we expect normal levels of volatility going forward. The fund remains defensively invested with ample liquidity to take advantage of any opportunities arising out of any market retracements that might present themselves during the next quarter.

During the quarter the managers added incremental spread by extending their exposure to iTraxx S44 Main 0-6% as well as an increased exposure to Series 43 iTraxx XOver index. Approximately 1.1% of capital was allocated to the South African State Owned Entity (SOE) Eskom as the managers feel that the short dated nature of the exposure is more than compensated for by the 128 bps risk spread that the instrument offered.

The fund currently has 42 instruments with a total of 360 obligors. The largest exposure is a 9.8% exposure to Goldman Sachs although this is across several instruments. The top 10 exposures accounts for approximately 60% of the fund but all of these exposures are to well known international bank names.

The fund currently has a DurationTimesSpread (DTS) measure at 10.1 which compares favourably to the index equivalent of around 12.2, again highlighting the defensive risk positioning of the fund.