London (HedgeNordic) – Bergen-based Borea Asset Management AS has been investing in Norwegian credit since 2004, and launched its flagship high yield fund in 2011. This period has included Europe’s sovereign debt crisis, and oil crises in Norway, but the long-term investor base has held steady. “We have never been forced sellers. We have annualized at over 8% since 2011,” says portfolio manager, Peer Hastrup Thorsheim. In March 2020, Borea was the only one of 13 Norwegian high yield managers (Alfred Berg; DNB AM; Eika; First Fondene; Fondsfinans; Handelsbanken; Holberg; Landkreditt; Odin Kreditt; Pareto AM; SR-Forvalting; Storebrand AM) to have seen net inflow, according to data from VFF and Pareto. “We did not have any liquidity issues in March 2020,” says Thorsheim.

The credit team including Thorsheim, CIO Willy Helleland, and portfolio manager Magnus Vie Sundal, have focus areas but all of them also work on all credit funds, providing full coverage if anyone is away. “We are co-pilots,” says Thorsheim.

Borea currently manages four strategies. The flagship fund, Borea Høyrente which recently received an HFM Emerging Manager Award in the Fixed Income (over USD 100 million) category, does not have a high degree of overlap with the other existing strategies, focused on Norwegian financials. The more than NOK4 billion (c. EUR 400 million) of assets in the flagship fund make it too large to build meaningful positions in some smaller issues. As a result, Borea has launched a new fund – Borea Kreditt – which will focus on high risk-reward opportunities in issues below NOK500 million (EUR50m) to obtain additional yield. It can also invest in larger issues in common with the other strategies, and as such is expected to have some overlap.

Lower asset purchases and higher yields

Norway has seen a strong recovery in credit from the Covid lows, mainly due to fundamentals rather than central bank asset purchases. In some markets central banks have become very large buyers of new issuance: the Fed is the biggest buyer of Treasuries and the ECB is the largest buyer of Bunds. The ECB has been buying corporate bonds since 2016 under several programmes: the asset purchase programme (APP) and corporate sector purchase programme (CSPP) and has recently accelerated its purchases with the Pandemic Emergency Purchase Programme (PEPP) initiated in 2020. In Norway, the government only started buying corporate bonds in 2020 after The Norwegian State Bond Fund (Statens Obligasjonsfond) was set up and it remains relatively small. “It has invested only NOK 8.9 billion of its NOK 50 billion mandate both through secondary and primary issuance. This compares to total issuance of NOK90bn in 2020, and more than 170bn so far this year,” says Thorsheim. The Norwegian high yield market is valued at NOK 500 billion including financials or NOK 360 billion excluding financials, according to Stamdata. Thus, the state owns less than 2% of the market.

Absolute yields are higher in Norway partly because local interest rates in NOK are a little higher than elsewhere in Western Europe. But credit spreads above interest rate benchmarks are also approximately 150 basis points wider than on European or US high yield, according to Thorsheim.

“In normal market conditions, Norwegian high yield has a bid/offer spread of 25-50 basis points, but in stressed conditions this can widen a lot even for bigger issues.”

The reasons for the extra yield have historically included a greater weighting in cyclical energy and shipping sectors, but this has become less relevant as the industrial composition has become more diversified – into Information technology, industrials, consumer discretionary, telecoms and healthcare – and some yield pickup continues. “It is partly an illiquidity premium,” says Thorsheim. “In normal market conditions, Norwegian high yield has a bid/offer spread of 25-50 basis points, but in stressed conditions this can widen a lot even for bigger issues,” he adds. Another possible explanation for the premium is that very few Norwegian high yield bonds have a credit rating, and could not be purchased by some ratings-constrained investors.

Smaller issues can offer a premium of 200-250 bps over comparable European or US debt. On top of the “Norway premium,” there is an extra illiquidity premium of about 100 basis points for smaller issues below NOK 500 million (EUR 50 million) in size. “This is difficult to measure exactly given the small sample size,” says Thorsheim.

Longer holding periods, new issues and aligning liquidity

While Borea wants to find smaller issues, there are also some constraints. The manager would typically not want to invest in issues below NOK 200 million (EUR 20 million) in size and does not want to own more than 25% of outstanding debt in any given issuer. “We always want some room to maneuver and 15-20% is more likely,” says Thorsheim.

These large positions are acquired mainly through primary issuance, since the secondary market is generally not liquid enough to provide large volumes, unless there is technical selling or a change in perception. Convertibles, which are occasionally invested in, would typically be acquired in the secondary market after they have cheapened, because the yields at issue are usually not high enough. New issues in the Nordic market usually have a 3–5-year maturity and Borea intends to hold until maturity but in practice better opportunities have historically come along so the average holding period is 2 years.

Although the smaller issues tend to be less liquid, and are priced thereafter, most of Borea’s holdings will be quoted in the market by counterparty brokers. Additionally, the new fund can invest up to 25% in direct and bilateral private loans, marked to market. To mitigate potential liquidity mismatches, there is a three-month lockup on the new mandate, which is longer than one month on the flagship fund and one week on the UCITS fund.

Leverage, FX hedges and rate risk

Borea can leverage up to 50% but typically uses leverage of 15-25%, resulting in gross exposure of 115-125%. The credit facility can also be used to manage margin requirements on currency hedging, which is mainly hedging USD, SEK and EUR issues back to NOK.

“We aim to avoid defaults but if there were any, we would be prepared to play an active role in restructurings.”

Interest rate risk could be hedged, but currently interest duration is only around one year because most of the exposure is floating rate. Of course, the floating rate exposure means that companies will have to pay more as NOK or USD interest rates rise, and Borea’s credit analysis is designed to ensure that they can afford higher interest payments. “We aim to avoid defaults but if there were any, we would be prepared to play an active role in restructurings,” says Thorsheim.

ESG and carbon transition

All of Borea’s strategies are classified as article 6 under SFDR. “ESG is not the main focus for any of our mandates, but we are keenly aware of the risks increased focus on ESG, and especially the “E” poses for companies in our investment universe. To us it seems that two camps in the ESG-discussion have emerged: those who plainly exclude companies, and those who try to influence companies from the inside. We are firmly in the second camp, and try to have a positive influence by lending to companies that want to reduce their carbon footprint or improve sustainability,” says Thorsheim.

“To us it seems that two camps in the ESG-discussion have emerged: those who plainly exclude companies, and those who try to influence companies from the inside. We are firmly in the second camp.”

Borea invests in carbon intensive sectors such as energy and shipping, but seeks to provide financing that helps them to reduce their environmental footprints. “Shipping companies could for instance replace a 20-year-old ship with a new one that has better propulsion technology, or uses LNG (liquid natural gas) rather than crude oil or heavy fuel, which would be a net positive for the environment,” Thorsheim points out.

This article features in HedgeNordic’s 2021 “Alternative Fixed Income” publication.