Fairtree Global Flexible Income Plus Fund Q4 2025 commentary

Market dynamics

Global risk

The global bull market, which started at the beginning of the second quarter, continued without much resistance into the fourth quarter of 2025, with equities across the board rallying strongly over the period. The large-cap Dow Jones Industrial Average delivered 4.03% to investors, but the rally in the US was dominated by large caps as the broader-based S&P 500 Index underperformed somewhat, producing a decent 2.65%. The NASDAQ followed the broader market, producing 2.72% in total return during the period. Looking at these numbers in terms of the historic dataset, the Dow Jones produced its 36th best quarter since Q2 2007 or some 75 quarters of data. So essentially the index produced an “average type” quarter, not far better than the series median return of 3.95%. Table 1 presents the total returns of the major Western equity indices for the fourth quarter, along with the rankings for the same period, to contextualise the returns. Looking purely at rankings, we can observe that the FTSE 100 was the pick of the bunch, delivering 6.86% and the 14th best ranked return of its history since Q2 2007.

Moving to the quarterly performance of European credit, the iTraxx suite of indices produced yet another set of positive numbers. The iTraxx Crossover 5-year Total Return Index produced another good quarter, posting 2.16%, which outperformed European cash quite comfortably. Our more favoured 2x levered index, a more realistic measure of the risk-adjusted relative performance of European credit, produced a healthy 3.82% 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 we feel that the index on a levered basis should offer a better risk-adjusted opportunity to investors who are willing to accept an excess premium to insure company credit.

On the default side of the coin, Markit reported one meaningful default over the quarter, that is Ardagh Packaging Finance PLC, which has been a component of iTraxx XOver Series 16 to Series 43. Series 16 was launched on 20 September 2011, and Series 43 was launched in March 2025. It subsequently fell out of the on-the-run Series 44 in September 2025, but has been an integral part of the European sub-investment-grade credit benchmark for some 15 years. At this juncture, the date has not been set for the recovery auction, but the market price indicates a recovery of around 40%, which is in line with average recoveries of sub-investment-grade credits.

Table 1: Major indices Q4 total return and historic rankings, Q2 2007 – Q4 2025

Source: Bloomberg, 31 December 2025

Given that we have 18.75 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, from a risk perspective, for one investor might be 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 consistent in its treatment of any distribution of potential outcomes. It does not rely on the distribution being “Normal” or Gaussian, but the formula can be applied to any set of data and is consistent in its approach. How one uses the standard deviation in conjunction with the mean return over the historic dataset is what might give us some insight into what “bang” we get for our “risk buck”.

We have always contended that excess returns to risk-free might only be a compensation for the risk (or uncertainty) of outcomes, and is grounded in a Capital Asset Pricing Model (CAPM) framework. We would suggest that 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 the 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 coefficient but might not deliver that much by the way of return. For example, it might be foolish to buy an index that produces 0.4% annual return with 0.2% annualised volatility – a return coefficient 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 the 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.

Table 2: Indices risk-adjusted return coefficient

Source: Bloomberg, 31 December 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 of 2007, when we have the complete historical data for the iTraxx XOver and Main total returns.

When looking at Figure 1, it also becomes apparent that there are no meaningful returns to risk-free. The worst performing traces over the 18.75 years are 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 that US Treasuries are not the least risky 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 18.75 years. This makes sense as the US Treasury index volatility is driven by the fluctuations in bond yields. The index has a modified duration of approximately 5.58%, while the iTraxx Main 5-year Total Return Index has a spread duration of 4.61%. When looking at the yield volatility of iTraxx Main and comparing it to US 10-year yield volatility, in basis points (bps), we compute the long-term yield volatility of iTraxx Main at 52 bps, whilst 10-year US Treasuries are at just under 88 bps. So higher yield volatility and higher sensitivity translate to outright higher price volatility.

Figure 1: Major indices total return, Q2 2007 – Q4 2025

Source: Bloomberg, 31 December 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 18.75 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.

Figure 2: Major indices risk/return scatterplot, Q2 2007 – Q4 2025

Source: Bloomberg, 31 December 2025

The domination of US equities in return terms, which was touched on earlier 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 Top 40 Total Return index, which is based in rand. In order to do a proper comparative study, we need to translate all the indices into a common currency, and then the comparison becomes more meaningful.

Moving to the economic backdrop, Figure 3 shows inflation in the developed world (the US, UK and the Eurozone), highlighting the fact that inflation is well off its highs hit in the fourth 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 (ECB) has essentially completed its interest rate cutting cycle, whilst the Bank of England’s position is looking rather tenuous.

UK CPI at 3.4% 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 to medium term. Of course, the UK is in a very distinctive quagmire, with a collapse in growth, triggered by some precarious policy settings coming from the Chancellor of the Exchequer, as well as a cabinet that seems to lack any plans on even formulating plans, which has resulted in a collapse in confidence and the subsequent increased probability of stagflation.

Luckily, the current Bank of England Governor, Andrew Bailey, is quite aware of the political tightrope he is currently balancing on and seems to have placed less emphasis on inflation and is currently paying more attention to economic output and the longer-term potential thereof. This should reduce the likelihood of rate hikes, but if the conundrum continues, the Governor might be forced to do the very thing that he does not want to do. Time will tell. Given the Governor’s background in the finer points of economic theory during the Napoleonic Wars, one might feel a little uncomfortable in his deep understanding of the current conundrum.

On a much more positive note, the European Union has finally hit the ECB’s 2% inflation target, and the current headline inflation number of 1.9% may just be tilting the ECB to offer one last cut in 2026.

Figure 3: Annual change in Consumer Price Indices, December 2010 – December 2025

Source: Bloomberg, 31 December 2025

Figure 4 below shows the level of short rates as administered by the US Federal Reserve, the European Central Bank and the Bank of England. What is of interest to note is the high levels of correlation in both the direction and the extent of policy movements. This mirrors Figure 3, which clearly shows the effects of globalisation and “free” trade between the differing economic blocks. One quickly realises that the so-called “Tariff War” has had little impetus in the movement in global inflation. The Eurozone shows stable to slightly lower inflation during 2025, the US has been largely flat, while it is only the UK that seems to be battling with the “inflation genie”. This is of little surprise given the state of affairs within that country. A growing population, largely driven by immigration, coupled with the flight of talent and associated capital due to the introduction of the taxation of earnings garnered outside the UK borders for those that are not permanently domiciled in the UK (non-doms), has resulted in many very productive expats leaving the UK. This obviously does not bode well for future tax takings, which have associated effects on UK Gilt issuance and therefore short rates and inflation.

Figure 4: Central bank administered rates

Source: Bloomberg, 31 December 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. It is interesting to point out both the high levels of correlation between these three traces and that developed global bond markets have had a rather pedestrian year.

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

Source: Bloomberg, 31 December 2025

Drilling into 2025, Table 4 below shows the movements in 10-year benchmark bond yields of the fourth quarter of 2025, the second half of 2025 as well as the calendar year. It is interesting to note that Euro Bunds actually sold off during the year, while US Treasuries rallied. UK Gilts remained largely intact, unable to show any gains, largely due to the uptick in inflation in that country.

Table 4: 10 – year benchmark bond yield movements in bps

Source: Bloomberg, 31 December 2025

Fund performance

The strategy of the Fairtree Global Flexible Income Plus Fund (the “Fund”) is to provide investors access to a well-diversified global credit portfolio that aims to outperform its benchmark, the iTraxx XOver Total Return Index (Bloomberg: ITRXTX5I), in EUR over the long term.

Table 5 shows the total performance of the Fund (Class A) relative to the iTraxx XOver Total Return Index, iTraxx Main Total Return Index and the Barclays 3-month EURIBOR Cash Index. The total returns vary from one month to five years, arguably showing the short-, medium- and long-run performance numbers. Unfortunately, the Fund had a bad fourth quarter of the year, underperforming the index by some 1.08%. The attribution of this underperformance is due to two specific factors:

1. Class A carries a total expense ratio of 0.95% per annum, so the quarterly loss due to fees alone amounts to around 0.24%
2. The Fund suffered a default at the end of the third quarter, which the market began discounting during the third quarter. The instrument ended Q3 at around 56%, which was down from 93% at the end of the second quarter, and then ended the fourth quarter at around 16% of face value. This cost the Fund cumulatively, but it only really hit the Fund’s numbers during the fourth quarter. Although the exposure was small, around EUR 500 000, the default cost the Fund some 0.24% during the quarter and has cost the Fund around 0.46% on a YTD basis.

Table 5: Fairtree Global Flexible Income Plus Fund (Class A) historic annualised total returns to end Q4 2025

Source: Bloomberg, 31 December 2025

When looking at Table 5, a few things become apparent.

1. Risk assets have all outperformed risk-free EURIBOR over all measurement periods. This might highlight the benefits of a long-term buy-and-hold strategy over a trading strategy.
2. The Fund has underperformed the index by some 0.80% per annum over the long run, but has outperformed this index on a pre-fees basis.
3. The Fund has delivered 4.42% per annum above risk-free EURIBOR over the calendar year and has outperformed cash by some 3.53% per annum over the past five years after all fees.

The Fund has a current weighted average spread to 3-month EURIBOR of 335 bps, which sits marginally higher than where it was at the end of Q3 (317 bps). This is primarily due to the fact that the Fund upped risk during the fourth quarter. We apportioned some 2.15% to an instrument issued by Citibank that references 2x levered iTraxx XOver S44. This was issued at a spread of 567 bps. The managers allocated 0.6% to an instrument referencing the 0-6% tranche of iTraxx Main S44. This was traded at a spread of 445 bps. Finally, we introduced a structured note issued by Morgan Stanley, which is a two-times levered iTraxx XOver S44 that pays a coupon of 3-month EURIBOR + 460 bps. This was traded in around 2.9% of the portfolio.

On the redemption side, Vodacom called their perpetual preference shares, which amounted to approximately 1.8%, whilst we had a maturity of a structured note issued by JP Morgan in around 0.6% of the fund. Net on net, the Fund utilised some 3.25% in new investments, which reduced the effects of cash drag.

Looking to Q1 2026, the Fund currently has a higher spread than the benchmark on a pre-fees basis, but with the TER currently at 0.95%, the managers have a bit more to do in order to exceed the performance of the index on a post-fees basis. The managers will continue to trade in the appropriate structured notes to meet this requirement. The managers have revisited the trading programme that was introduced some time ago, as they are now cognisant of the fact that this global risk bull run may extend for quite some time still.