Stockholm (HedgeNordic) – The Nordic high-yield market, characterized by lower liquidity, limited transparency, a higher prevalence of smaller issuers, and a predominantly floating-rate structure in contrast to its European and American counterparts, has consistently commanded a credit premium of approximately 200 basis points. Recognizing these particular characteristics – which also present challenges – Christoffer Malmström and Måns Levin designed a specific strategy within a more alternative and flexible structure to seize opportunities in the Nordic high-yield corporate bond market.
The two friends, who first crossed paths during their Master’s studies at the Stockholm School of Economics almost two decades ago, embarked on separate career paths in different financial hubs before reuniting to establish Ridge Capital. Their shared dream of launching their own venture led them to launch Ridge Capital’s high-yield bond strategy. With over 13 years of credit investing experience in London, New York and Stockholm, Malmström acts as the lead portfolio manager of the high-yield-focused strategy within a Luxembourg-domiciled structure reserved for professional investors, called Northern Yield.
Flexible and Alternative Structure
“Northern Yield invests in Nordic high-yield corporate bonds using what we call an unconventional approach with a focus on capital preservation,” explains Levin, who serves as CEO of the firm. Most players active in the Nordic high-yield bond market structure their investment vehicles as UCITS funds, offering daily liquidity to their investors. However, this structure creates a liquidity mismatch between a fund’s liquidity profile and the liquidity of its holdings. This mismatch became evident during the market turmoil in March 2020 when several corporate bond funds had to be gated due to substantial investor outflows.
“Northern Yield invests in Nordic high-yield corporate bonds using what we call an unconventional approach with a focus on capital preservation.”
To address this liquidity mismatch, the duo behind Ridge Capital opted to target longer-oriented professional and institutional investors with a more unconventional strategy. By structuring the Northern Yield within an alternative investment structure, they can better manage this liquidity challenge by offering monthly liquidity to investors and requiring a 30 bank days notice for redemptions. Anchor investors have committed to lock up their capital for two years. “This structure gives us much more flexibility to manage the portfolio, allowing us to focus more on bond and credit analysis as well as due diligence instead of constantly monitoring investor flows,” elaborates Malmström. “We thrive in inefficient markets.”
“This structure gives us much more flexibility to manage the portfolio, allowing us to focus more on bond and credit analysis as well as due diligence…”
Ridge Capital’s structure also enables the team to maintain a more concentrated portfolio, with Northern Yield currently holding about 40 different bonds across around 30 issuers. “We have a more focused portfolio compared to many of our peers, which allows us to do in-depth analysis on each company,” explains Malmström. “Our key focus is on credit analysis and default avoidance,” he elaborates, emphasizing that a focused portfolio allows more time and attention to each holding. This concentration underscores the team’s commitment to true active management, as the team eschews employing a “buy & hold” or “buy everything” approach.
Use of Leverage
By design, Northern Yield has the ability to employ leverage, which on average will be around 150 percent of invested capital (i.e., two-thirds of the portfolio is financed with investor’s capital and one-third with debt). The strategic use of leverage functions as a tool in the team’s arsenal for managing occasional patches of dry liquidity and reaching their goal of attaining equity-like returns at lower volatility. “The leverage we can employ is a source of liquidity for us,” according to Levin.
“Leverage also helps us in our objective to generate equity-like returns without going too far out of the risk spectrum,” elaborates Malmström. “With leverage, we can buy bonds that are yielding a bit less but are not as risky, and yet achieve our return objectives.” The usage of leverage to meet its return objectives allows the team to run a more defensive exposure. “For example, we do not invest in the volatile fossil fuel sector, which has five times more defaults than other sectors,” explains Malmström.
“Leverage also helps us in our objective to generate equity-like returns without going too far out of the risk spectrum.”
Northern Yield targets a long-term annual return of base rate plus seven percent per annum with an annual volatility of less than five percent, which in today’s interest rate environment equates to more than 10 percent per annum. Ridge Capital Northern Yield has performed well since its launch in early 2023, delivering a cumulative return of 5.7 percent over its initial eight months of operation. Since it became fully invested in April, it has produced an average return of 1.1 percent per month, with a yield-to-maturity of 12 percent without leverage and slightly over 16 percent with the structural 150 percent leverage.
Outlook
“The Nordic high-yield market will continue to offer great opportunities and strong returns in the coming months and years,” predicts Levin. “Higher interest rates and risk-premiums all play to our advantage, as we get paid more by borrowers, and we don’t expect a decrease in either of those two in the near future,” he continues. The flip side, of course, is that given that the Nordic high-yield market predominantly features floating-rate bonds, the inability of some indebted companies to manage debt can add to default situations in the near future.
“We can’t emphasize enough that credit selection is key in this market.”
This floating rate structure, therefore, can be both advantageous and challenging for investors. “We can’t emphasize enough that credit selection is key in this market,” emphasizes Malmström. “Passive, or over-diversified, strategies, with little to no credit analysis before investment, will be severely hurt by increased default levels,” he elaborates. “Even though credit defaults will continue rising, we are very well prepared to face this market phase thanks to our deep systematic rigorous credit analysis, in combination with a focused and active portfolio,” says Levin. “This is the right setup in this asset class to avoid credit events.”
