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Relative Value Paid Off in Fixed-Income Turmoil

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Stockholm (HedgeNordic) – Fixed-income assets and fund managers focused on the space faced a challenging 2022, “a year many investors would have liked to have missed,” according to Henrik Stille, a portfolio manager at Nordea. The European-focused relative value fixed-income hedge fund he runs out of Copenhagen navigated the turmoil to advance 10.2 percent in 2022, ending the year as the best-performing fixed-income vehicle in the Nordic hedge fund universe.

A combination of factors such as Russia’s war in Ukraine, high energy prices, and pandemic-induced supply chain issues, among others, led to inflation reaching levels not seen in decades. Central banks’ aggressive steps to fight inflation sent shockwaves through financial markets and economies. “The movements in the financial markets were not absent, with large falls across stock markets, very large interest rate increases and spread widening, and, on the whole, nervous and very volatile markets,” says Stille. “Certain segments of fixed-income markets experienced losses that were worse than during the financial crisis in 2008/09.”

One of a Handful

Against a backdrop of rising rates, widening spreads and great uncertainty, Nordea’s European Rate Opportunity Fund was one of the few fixed-income funds in the Nordics to end 2022 in positive territory. The relative value vehicle booked an advance of 10.2 percent for the year to reach an annualized return of 7.7 percent since launching in mid-2019. “It is a pleasure that our systematic work to find relative value and our work to put together the right risk exposure in our European Rate Opportunity Fund bore fruit,” Stille comments on the solid 2022 performance.

“It is a pleasure that our systematic work to find relative value and our work to put together the right risk exposure in our European Rate Opportunity Fund bore fruit.”

Nordea European Rate Opportunity Fund seeks to capture relative value opportunities in the universe of covered bonds and government bonds, predominantly European covered bonds. Instead of maintaining directional exposure, the fund builds positions that offer attractive relative value, typically with no interest rate risk. “We can take interest rate risk if our risk model indicates this exposure can improve our overall risk composition,” points out Stille. “In the same way, we would like our returns to be driven by credit beta as little as possible,” he emphasizes.

The starting point in the process of finding relative value is analyzing individual countries, understanding the strengths and weaknesses of the individual issuers, the pricing of covered bonds against, for example, government bonds in the individual countries, but also the pricing of the issuers’ senior debt in relation to covered bonds, according to Stille. “Finding the best relative value options is only the starting point,” he explains. “Based on our risk model, we can then identify correlations and the best possible and optimal risk-mitigating trades that offer the best possible expected risk-adjusted return.”

“In a particularly difficult investment year like 2022, it was satisfying to see our risk and correlation model work satisfactorily and contribute to a fine result for 2022.”

One of the trades Stille and his team identified in the autumn of 2021 as risk mitigating in relation to quantitative tightening and an environment of rising interest rates and widening credit spreads involved curve-flattening trades in various forms. “In a particularly difficult investment year like 2022, it was satisfying to see our risk and correlation model work satisfactorily and contribute to a fine result for 2022,” says Stille.

After a successful 2022 in a difficult environment for fixed-income markets and Nordic covered bonds in particular, Stille continues to consider this “an asset class with high credit quality that offers attractive risk/return characteristics.” According to Stille, the covered bonds market is growing with the circulating amount of bonds under covered bond legislation reaching about €3 trillion. “Covered bonds have been our home investment market for more than ten years in our long-only products, and we have a proven track record in this space after succeeding in delivering positive alpha in all the years since we started in 2012.”

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Eugeniu Guzun
Eugeniu Guzun
Eugeniu Guzun serves as a data analyst responsible for maintaining and gatekeeping the Nordic Hedge Index, and as a journalist covering the Nordic hedge fund industry for HedgeNordic. Eugeniu completed his Master’s degree at the Stockholm School of Economics in 2018. Write to Eugeniu Guzun at eugene@hedgenordic.com

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