Nimbleness in the Credit Space

Stockholm (HedgeNordic) – As the market environment remains uncertain and interest rates are hovering around zero, traditional bond holdings provide little protection to portfolios in times of market turmoil and virtually guarantee no returns in the immediate future. Unsurprisingly, many investors are looking for fixed-income replacements for their portfolios, with alternatives becoming increasingly important. “Alternatives have become a big focus at UBP because of where we are in the cycle, and hedge funds can provide differentiated sources of return,” John Argi, Co-Head of Alternative Investment Solutions at UBP, tells HedgeNordic.

“Investors are seeking to complement or replace the traditional fixed-income bucket, what used to be an allocation to corporate investment grade,” he points out. “If you want a less risky allocation to fixed income, it is almost impossible to get even positive yield,” Argi shares a common concern on many investors’ minds. To escape this return-free risk morass, investors are increasingly looking at alternatives such as the US-high-yield-focused long/short credit strategy run by New York-based Global Credit Advisers (GCA). “GCA brings very deep expertise in the credit long/short space. Its strategy is one of the most interesting we’ve come across, successfully generating good and stable performance throughout its long track record, it explains why we have chosen to partner with GCA,” says Argi.

“Investors are seeking to complement or replace the traditional fixed-income bucket, what used to be an allocation to corporate investment grade.”

Founded and steered by Chief Investment Officer Steven Hornstein (pictured), GCA employs a long/short corporate credit strategy engaged in sector-based investing primarily in the high-yield segment in US markets. GCA’s investment process relies on a collaborative environment involving sector specialists, a credit committee, and one primary decision maker, the Chief Investment Officer, who has more than 35 years of experience in high-yield investing. “Our long/short corporate credit strategy is about credit selection, predominantly in high yield,” Hornstein tells HedgeNordic. “This is something I have been doing for close to four decades.”

“Our long/short corporate credit strategy is about credit selection, predominantly in high yield. We predominantly invest in US high yield, but we can invest in European high yield as well.”

“We predominantly invest in US high yield, but we can invest in European high yield as well,” says Hornstein. “We don’t do emerging markets, we don’t do structured products. We only do what we know,” he continues. “We stick to our core competency and our pedigree, which, in our world, represents a rather large sandbox.” Despite focusing on US high yields, GCA’s portfolios have the flexibility to invest across the entire credit spectrum, from investment grade all the way down to deeply distressed securities.

“The strategy combines a bottom-up approach to sector and single-name selection with a macro overlay.”

“The strategy is opportunistic, very sector dynamic and marries fundamental research and a lot of trading expertise on valuations, price points, dispersion, default rates, global economic environment, interest rates, and so on,” Hornstein goes on to say. “The strategy combines a bottom-up approach to sector and single-name selection with a macro overlay.” GCA’s strategy, therefore, relies on the team’s vast experience in credit markets to find and capitalise on investment themes across different sectors.

Thematic Investing Across Sectors

Hornstein and his team of eight investment professionals typically build the portfolio allocation around three or more themes. Still, fast-changing environments can broaden the range of themes reflected in the portfolio. “The portfolio usually reflects three to four reasonably large themes that have short-term, medium-term and long-term implications,” says Hornstein. “Given the number of sectors that we cover, we can have as many as eight themes reflected in the portfolio, especially in an environment that is undergoing a lot of significant structural changes with fast-changing outlooks either on the positive or negative side.”

Whereas Hornstein has the final say on what goes into the portfolio, his team of analysts provide the input for the decision-making process. “The portfolio reflects what the analysts are seeing on the field in their sectors,” explains Hornstein. “We don’t have a team of analysts just roaming around the world, looking for hotspots or looking for the next trade,” he continues, “everything really comes through the research team, as analysts have their core coverage focusing on one, two or three sectors.” As soon as various themes start taking shape during team discussions, single-name selection becomes the focus. Each theme can reflect two to three positions in single names to as many as five to ten, “depending on how we think we can extract the best return potential.”

“The portfolio reflects what the analysts are seeing on the field in their sectors. We don’t have a team of analysts just roaming around the world, looking for hotspots or looking for the next trade.”

“In summary, the six analysts will pitch ideas from their sectors,” says Brian Hessel, Co-Founder and COO. The team of analysts presents ideas to the credit committee composed of Hornstein, Hessel and the Head Trader, David daCruz. “Their objective is to convince us that an idea makes sense,” explains Hessel. “Then Steve and David do a lot of work on ways to best express the trade, whether it is just going to be a directional long or potentially a long/ short in the same capital structure or across different companies.”

Shorts and Longs as Profit Centres

GCA portfolios typically maintain between 50– 150 single-name long and short positions across 100–150 issuers. “On the long side, we are looking for companies that show increasing cash flows, companies that use their cash flows to pay down their debt and improve their credit quality,” says Hessel. “On the short side, we are looking for the opposite.”

Short books can play different roles for long/short managers, including alpha centres, profit centres and hedge centres. The team running GCA’s strategy aims to, “generate a return on both sides of the portfolio,” according to Hessel. “Our short book is not necessarily a hedge for the long book: it is a profit centre on its own.” Looking at 2020 in particular, the fund’s short exposure contributed more to returns than the long exposure.

“Our short book is not necessarily a hedge for the long book: it is a profit centre on its own.”

The strategy has delivered a positive net return through the end of November, successfully managing to scoop up gains even in the turbulent first quarter. “Early on in the COVID days, we realised the challenges that a lot of these levered companies might be exposed to because of the shutdowns and lockdowns,” says Hornstein. “We had to act pretty quick because we had 2019 closing out with very strong consumer demand, low interest rates, reasonably good equity valuations, and a relatively calm market environment,” Hornstein points out. “With the trade deal behind us, market participants had some reasons to be pretty optimistic and that changed very quickly due to the pandemic.”

On the short side, the team looked at sectors and companies that were going to suffer from the lockdowns. “At the beginning, we put together a rather reasonably sized short book on the lodging, leisure and entertainment space,” which strongly contributed to the 2020 performance. “As we got through the worst of the lockdown period, and then things started to open up a little bit, we had to be equally as quick to get back to take those short positions off,” Hornstein emphasises. “Then we had to go back to what can benefit from this, where do we see some meaningful benefit,” said Hornstein, such as the at-home trade.

Overall, the two themes that contributed most to the performance of the portfolio in 2020 were, “the broader at-home trade, which had a number of components to it, and the shutdown trade that sought to capitalise on what sectors were going to be seriously impacted,” says Hornstein. “At the macro level, those were the two big ones, but then we could dissect them across several sectors and sub-sectors.”

“The edge is really the decades of experience through credit cycles, market cycles, interest rate cycles, sector cycles. The nimbleness of the team is the real edge, especially in a year like 2020.”

The nimbleness of the team, facilitated by the many years of experience of the entire team, has enabled the strategy to navigate the difficult market environment in the first quarter of 2020 and other market conditions for over 13 years. “The edge is really the decades of experience through credit cycles, market cycles, interest rate cycles, sector cycles,” concludes Hornstein. “The nimbleness of the team is the real edge, especially in a year like 2020.”

 

This article featured in HedgeNordic’s report Alternative Fixed Income Strategies.

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About Author

Eugeniu Guzun serves as a data analyst responsible for maintaining and gatekeeping the Nordic Hedge Index (NHX), as well as being a novice columnist covering the Nordic hedge fund industry for HedgeNordic. Prior to joining HedgeNordic, Eugeniu had served as a columnist for a U.S. journal covering insider trading activity, activist campaigns and hedge fund moves. Eugeniu completed his Master’s degree at the Stockholm School of Economics in 2018.

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